Joseph E. Stiglitz

August 2012


The euro crisis and the Great Recession which led to it present several puzzles for traditional economic theories. In the last 30 years crises have become more frequent and expensive than ever – at the same time that many economists believe markets are better and there is more widespread understanding of how to manage economies. Moreover, there are seldom changes in the state variables (capital, human capital, etc.) describing an economy that can account for the dramatic changes in outcomes. In this paper, after providing a general theory of crises, in which multiple short run and steady state equilibria and discontinuities in expectations play critical roles, we focus on the role of adjustment, the reasons that requisite adjustments sometimes don’t occur, and why natural decentralized “adjustment” processes may be disequilibrating. The role of excess indebtedness, often associated with crises, poses a particular puzzle, since standard theories argue that whatever the level of indebtedness, there is a full employment equilibrium. We explain why indebtedness may have persistent adverse effects. Finally, we discuss the implications of these findings for Europe, providing an explanation for why the downturn has been especially persistent there.

View the paper here: Crises: Principles and Policies, with an Application to the Eurozone Crisis