International Economic Association

CONTEMPORARY ISSUES IN MACROECONOMICS Lessons from the Crisis and Beyond Edited by Joseph E. Stiglitz CONTEMPORARY ISSUES IN MICROECONOMICS Edited by Joseph E. Stiglitz CONTEMPORARY ISSUES IN DEVELOPMENT ECONOMICS Edited by Timothy Besley TAMING CAPITAL FLOWS Capital Account Management in an Era of Globalization Edited by Joseph E. Stiglitz and Refet Gurkaynak LIFE AFTER DEBT The Origins and Resolutions of Debt Crisis Edited by Joseph E. Stiglitz and Daniel Heymann INCOME CONTINGENT LOANS Theory, Practice and Prospects Edited by Joseph E. Stiglitz, Bruce Chapman and Timothy Higgins THE INDUSTRIAL POLICY REVOLUTION I The Role of Government Beyond Ideology Edited by Joseph E. Stiglitz and Justin Lin Yifu THE INDUSTRIAL POLICY REVOLUTION II Africa in the 21st Century Edited by Joseph E. Stiglitz, Justin Lin Yifu and Ebrahim Patel THE CHINESE ECONOMY A New Transition Edited by Masahiko Aoki and Jinglian Wu INSTITUTIONS AND COMPARATIVE ECONOMIC DEVELOPMENT Edited by Franklin Allen, Masahiko Aoki, Nobuhiro Kiyotaki, Roger Gordon, Joseph E. Stiglitz and Jean-Paul Fitoussi COMPLEXITY AND INSTITUTIONS: MARKETS, NORMS AND CORPORATIONS Edited by Masahiko Aoki, Kenneth Binmore, Simon Deakin and Herbert Gintis CORPORATE SOCIAL RESPONSIBILITY AND CORPORATE GOVERNANCE The Contribution of Economic Theory and Related Disciplines Edited by Lorenzo Sacconi, Margaret Blair, R. Edward Freeman and Alessandro Vercelli IS ECONOMIC GROWTH SUSTAINABLE? Edited by Geoffrey Heal KEYNE’S GENERAL THEORY AFTER SEVENTY YEARS Edited by Robert Diman, Robert Mundell and Alessandro Vercelli CORRUPTION, DEVELOPMENT AND INSTITUTIONAL DESIGN Edited by János Kornai, László Mátyás and Gérard Roland MARKET AND SOCIALISM In the Light of the Experience of China and Vietnam Edited by János Kornai and Yingyi Quian INSTITUTIONAL CHANGE AND ECONOMIC BEHAVIOUR Edited by János Kornai, László Mátyás and Gérard Roland INTERGENERATIONAL EQUITY AND SUSTAINABILITY Edited by John E. Roemer and Kotaro Suzumura PSYCHOLOCY, RATIONALITY AND ECONOMIC BEHAVIOUR Challenging Standard Assumptions Edited by Bina Agarwal and Alessandro Vercelli MULTINATIONALS AND FOREIGN INVESTMENT IN ECONOMC DEVELOPMENT Edited by Edward M. Graham POST-CONFLICT ECONOMIES IN AFRICA Edited by Paul Collier and Augustin Kwasi Fosu STRUCTURAL REFORM AND MACROECONOMIC POLICY Edited by Robert M. Solow THE PAST, PRESENT AND FUTURE OF THE EUROPEAN UNION Edited by Alan V. Deardorff LATIN AMERICAN ECONOMIC CRISES Trade and Labour Edited by Enrique Bour, Daniel Heymann and Fernando Navajas ADVANCES IN MACROECONOMIC THEORY Edited by Jacques H, Drèze EXPLAINING GROWTH A Global Research Project Edited by Gary McMahon and Lyn Squire TRADE, INVESTMENT, MIGRATION AND LABOUR MARKET ADJUSTMENT Edited by David Greenaway, Richard Upward and Katherine Wakelin INEQUALITY AROUND THE WORLD Edited by Richard B. Freeman MONETARY THEORY AND POLICY EXPERIENCE Edited by Axel Leijonhufvud MONETARY THEORY AS A BASIS FOR MONETARY POLICY Edited by Axel Leijonhufvud ECONOMIC DEVELOPMENT IN SUBSAHARAN AFRICA Proceedings of the Eleventh World Congress of the International Economic Association, Tunis Edited by Ibrahim Elbadawi and Beno Ndula

International Economics Association Series Standing Order ISBN 978–0–3337–1242–9 (Hardback) 978–0–3338–0330–1 (Paperback) You can receive future titles in this series as they are published by placing a standing order. Please contact your bookseller or, in case of difficulty, write to us at the address below with your name and address, the title of the series and one of the ISBNs quoted above. Customer Services Department, Macmillan Distribution Ltd, Houndmills, Basingstoke, Hampshire RG21 6XS, England Contemporary Issues in Macroeconomics Lessons from The Crisis and Beyond

Edited by

Joseph E. Stiglitz University Professor, Columbia University, USA and

Martin Guzman Postdoctoral Research Fellow, Columbia University Business School, USA, and Associate Professor, University of Buenos Aires, Argentina Selection and editorial matter © Joseph E. Stiglitz and Martin Guzman 2016 Individual chapters © Contributors 2016 Softcover reprint of the hardcover 1st edition 2016 978-1-137-52957-2 All rights reserved. No reproduction, copy or transmission of this publication may be made without written permission. No portion of this publication may be reproduced, copied or transmitted save with written permission or in accordance with the provisions of the Copyright, Designs and Patents Act 1988, or under the terms of any licence permitting limited copying issued by the Copyright Licensing Agency, Saffron House, 6–10 Kirby Street, London EC1N 8TS. Any person who does any unauthorized act in relation to this publication may be liable to criminal prosecution and civil claims for damages. The authors have asserted their rights to be identified as the authors of this work in accordance with the Copyright, Designs and Patents Act 1988. First published 2016 by PALGRAVE MACMILLAN Palgrave Macmillan in the UK is an imprint of Macmillan Publishers Limited, registered in England, company number 785998, of Houndmills, Basingstoke, Hampshire RG21 6XS. Palgrave Macmillan in the US is a division of St Martins Press LLC, 175 Fifth Avenue, New York, NY 10010. Palgrave Macmillan is the global academic imprint of the above companies and has companies and representatives throughout the world. Palgrave® and Macmillan® are registered trademarks in the United States, the United Kingdom, Europe and other countries ISBN 978-1-137-57933-1 ISBN 978-1-137-52958-9 (eBook) DOI 10.1057/9781137529589 This book is printed on paper suitable for recycling and made from fully managed and sustained forest sources. Logging, pulping and manufacturing processes are expected to conform to the environmental regulations of the country of origin. A catalogue record for this book is available from the British Library. Library of Congress Cataloging-in-Publication Data International Economic Association. World Congress (17th : 2014 : Jordan), sponsoring body. Contemporary issues in macroeconomics : lessons from the crisis and beyond / Joseph E. Stiglitz. pages cm “These essays were presented at the 17th World Congress of the International Economic Association held in Jordan, June 6–10, 2014”–Preface.

1. Monetary policy. 2. Finance. 3. Financial crises. 4. Macroeconomics. I. Stiglitz, Joseph E., editor. II. Title. HG230.3.I5764 2016 339–dc23 2015027050 Contents

List of Figures vii List of Tables viii Foreword ix Notes on Contributors x

Introduction 1

Keynote Addresses by Central Bank Governors

1 The Practice and Theory of Unconventional Monetary Policy 7 Haruhiko Kuroda

2 Monetary Policy in a Constrained Environment 15 Ziad Fariz

Part I Macroeconomic Theory for Understanding Fluctuations and Crises

3 A Theory of Pseudo-Wealth 21 Martin Guzman and Joseph E. Stiglitz

4 Great Recession and Beyond: Revisiting the Pillars of Economic Thought 34 A. Erinc Yeldan

5 Is Financial Stability Possible in the Current International System? 42 James M. Boughton

6 Learning, Expectations, and the Financial Instability Hypothesis 50 Martin Guzman and Peter Howitt

Part II The Measurement of Wealth

7 The Measurement of Wealth: Recessions, Sustainability and Inequality 63 Joseph E. Stiglitz

v vi Contents

Part III Macroeconomic Policies in Unstable Times

8 The Short- and Long-Run Damages of Fiscal Austerity: Keynes beyond Schumpeter 79 Giovanni Dosi, Mauro Napoletano, Andrea Roventini, and Tania Treibich

9 Structural Divergence and Crisis in the Eurozone: The Role of NAIRU Economics 101 Servaas Storm and C.W.M. Naastepad

10 Managing the Exchange Rate in the Face of Volatile Capital Flows 129 Jonathan D. Ostry

11 Achieving Coherence Between Macroeconomic and Development Objectives 148 Gerald Epstein

Part IV Central Banking and Monetary Policy

12 Re-imagining Central Banking 163 Perry Mehrling

13 Taking Banks to Solow 176 Hans Gersbach, Jean-Charles Rochet, and Martin Scheffel

Index 199 List of Figures

3.1 Space of states 23 4.1 Investment–saving equilibrium in the loanable funds market 36 4.2 Determination of the interest rate in the Keynesian system 37 4.3 Share of investment in GDP in advanced economies 39 4.4 GDP ratios in advanced economies and EMEs % 39 7.1 USA growth below trend 69 7.2 Europe growth below trend 70 8.1 The structure of the Keynes + Schumpeter model 82 8.2 Model-generated macroeconomic series 88 8.3 Duration of recessions: simulated data and exponential fit 90 8.4 GDP growth-rate distribution: simulated data vs normal fit 91 9.1 Increasing the share of high- & medium-high tech manufacturing means improving the current account 114 9.2 ECB inflation targeting 121 10.1 Policy response to a demand shock 139 10.2 Policy response to a capital inflow shock 140 13.1 E¯(K)-function 184 13.2 Response to wealth shocks 192

vii List of Tables

8.1 Economic performance under alternative fiscal policies. Monte Carlo averages. (SGP): Structural and Growth Pact fiscal rule. (*): the H0: “no difference between baseline and the SGP fiscal rule” is rejected at 1% level 91 9.1 Eurozone: Real Interest Rates and Domestic Demand Growth (1992–99 and 2000–2007) 105 9.2 Real Gross Fixed Capital Formation and rates of return on capital: Germany, Italy and Spain (1992–99 versus 2000–2007) 107 9.3 Change in net financial assets by sector (2001–2008) (percentage of GDP) 108 9.4 Value added share (relative to Germany’s), 1999 and 2007 (percentage differences) 110 9.5 Structure of Growth (1990–2007) (average annual percentage rate of growth) 111 9.6 Wage and labour productivity gaps: Eurozone versus Germany (%) 112 9.7 NAIRU estimates: OECD (% of labour force) 120 10.1 Studies on sterilized intervention in emerging market economies 133 12.1 Fed’s balance sheet, before and after the crisis 167 12.2 Federal Reserve (July 6, 2011), in trillions, restated 167 12.3 Fed’s balance sheet, April 2014 168 12.4 A market-based credit system 170 13.1 Parameters and calibration targets 190 13.2 Steady-state allocation and non-targeted statistics 191

viii Foreword

These essays were presented at the 17th World Congress of the International Economic Association held in Jordan, June 6–10, 2014. It was organized in part- nership with the Columbia Global Centres – Middle East (Amman) and with generous support from a range of sponsors. The five-day program included five plenary sessions, 24 invited sessions, 15 policy sessions and over 90 contributed sessions, with over 600 people in attendance. The selection of papers in this vol- ume gives a flavour of the range of issues that were discussed in the congress sessions which brought together a group of established and younger scholars from all over the world. The IEA is a fine example of international cooperation in the discipline of economics. The success of the congress owed much to the energy and commitment of the IEA President at the time, Joseph Stiglitz.

Timothy Besley, London, May 2015

ix Notes on Contributors

Timothy Besley is School Professor of Economics and Political Science and W. Arthur Lewis Professor of Development Economics at the London School of Eco- nomics. He served on the Bank of England’s Monetary Policy Committee from September 2006 to August 2009. He is a member of the Institutions, Organi- zations and Growth Program of the Canadian Institute for Advanced Research and his research interests are focused on aspects of economic policy forma- tion. He is a Fellow of the British Academy and the Econometric Society and is a foreign honorary member of the American Economic Association and the American Academy of Arts and Sciences. He is also a past co-editor of the Amer- ican Economic Review and has served on the board of numerous academic journals. In 2010 he served as president of the European Economic Associa- tion and from 2014 to 2017, he is serving as the President of the International Economic Association. In 2005, he won the Yrjö Jahnsson Award for European economics.

James Boughton is a senior fellow at the Centre for International Governance Innovation (CIGI). From 1992 to 2012 he was Historian of the International Monetary Fund. From 1981 until he was named Historian, he held various posi- tions in the IMF Research Department. He holds a PhD in Economics from Duke University, and before joining the IMF staff, he was Professor of Economics at Indiana University and had served as an economist at the OECD in Paris. His recent publications include two volumes of IMF history, Silent Revolution: The International Monetary Fund 1979–1989 and Tearing Down Walls: The International Monetary Fund 1990–1999.

Giovanni Dosi is Professor of Economics and Director of the Institute of Eco- nomics at the Scuola Superiore Sant’Anna in Pisa. He is also co-director of the task forces “Industrial Policy” and “Intellectual Property Rights”, IPD - Initiative for Policy Dialogue at Columbia University. He is the Continental European Edi- tor of Industrial and Corporate Change. A member of the Accademia Nazionale dei Lincei, his major research areas include the economics of innovation and techno- logical change, industrial economics, evolutionary theory, economic growth and development, and organizational studies. A selection of his works has been pub- lished in two volumes: Innovation, Organization and Economic Dynamics. Selected Essays (2000), and Economic Organization, Industrial Dynamics and Development: Selected Essays (2012).

x Notes on Contributors xi

Gerald Epstein is Professor of Economics and a founding Co-Director of the Political Economy Research Institute (PERI) at the University of Massachusetts, Amherst. He received his PhD in Economics from Princeton University in 1981. He has written articles on numerous topics including financial crisis and regula- tion, alternative approaches to central banking for employment generation and poverty reduction, and the political economy of financial markets and institu- tions. His most recent edited volume is The Handbook of The Political Economy of Financial Crises (2013, co-edited with Martin Wolfson).

His Excellency Dr Ziad Fariz was appointed, by royal decree, Governor of the Central Bank of Jordan (CBJ) for a second period of office starting in Jan- uary 2012. His first term lasted from 1996 to 2001. He previously served as Deputy Prime Minister, Minister of Finance, Minister of Planning and Inter- national Cooperation (1991–1994), Minister of Industry and Trade (1989–1991) and General Secretary of the Ministry of Planning and International Cooperation (1984–1989). He has chaired the boards of several financial institutions includ- ing the First Investment Group and Capital Bank. He holds a PhD in Economics from Keele University, UK and started his career in the research department of the Central Bank of Jordan in 1966.

Hans Gersbach holds the Chair of Macroeconomics: Innovation and Policy at ETH Zurich Switzerland. He is also one of the Directors of CER-ETH – Center of Economic Research at ETH Zurich and a CEPR-Research Fellow in Public Policy and Industrial Organization. He is Chairman of the Academic Advisory Board at the Federal Ministry for Economic Affairs and Energy in Germany, Chairman of the Steering Committee of the ETH Risk Center and a member of the Steering Committee of the KOF Swiss Economic Institute at ETH Zurich. He is also an IZA and a CESifo Research Fellow. His current research focuses on the design of new economic and political institutions for the well-being of societies. It also includes macroeconomic policy design, innovation and growth, epidemic diseases and financial stability.

Martin Guzman is a postdoctoral research fellow at the Department of Eco- nomics and Finance, Columbia University Business School and an Associate Professor at the University of Buenos Aires. He is also a member of the INET Taskforce on Macroeconomic Externalities, a Senior Fellow at the Centre for International Governance Innovation (CIGI, Canada), and the Editor of the Journal of Globalization and Development.

Peter Howitt is the Lyn Crost Professor of Social Sciences at Brown University. He has been a Fellow of the Econometric Society since 1994 and a Fellow of the Royal Society of Canada since 1992. He served as President of the Canadian Economics Association in 1993–1994 and was the editor of the Journal of Money, Credit, and Banking in the period 1997–2000. xii Notes on Contributors

Haruhiko Kuroda was appointed Governor of the Bank of Japan in March 2013 after serving for eight years as President of the Asian Development Bank. Throughout his career at the Ministry of Finance in Japan from 1967, his respon- sibilities encompassed fields including international finance and national and international tax, as well as duties in the finance minister’s office. He repre- sented the Ministry at a number of international monetary conferences as Vice Minister of Finance for International Affairs, such as meetings of the Group of Seven Finance Ministers and Central Bank Governors, International Monetary Fund/World Bank Joint Annual Meetings, and bilateral meetings between Japan and other countries/regions. He was Special Adviser to the Cabinet of Prime Minister Junichiro Koizumi, and was also a professor at the Graduate School of Economics of Hitotsubashi University in Tokyo from 2003 to 2005.

Perry G. Mehrling is Professor of Economics at Barnard College, where he teaches courses on the economics of money and banking, the history of money and finance, and the financial dimensions of the U.S. retirement, health, and education systems. His most recent book is The New Lombard Street: How the Fed became the dealer of last resort (2011). His best-known book is Fischer Black and the Revolutionary Idea of Finance (2005). He directs the educational initiatives of the Institute for New Economic Thinking, one of which is his course Economics of Money and Banking, available on Coursera at www.coursera.org/course/ money.

C.W.M. Naastepad has worked on real-financial computable general equilibrium (CGE) models and on economic policies conducive to technological progress and productivity growth. Her most recent book (co-authored with Servaas Storm) is Macroeconomics Beyond the NAIRU (2012), which was awarded the EAEPE Gun- nar Myrdal Prize in 2013. She is a member of the Institute for New Economic Thinking Working Group on the Political Economy of Distribution. Her cur- rent research concerns how both narrower and wider conceptions of capital and progress affect the direction of technological change and the co-evolution of technology, economy and society.

Mauro Napoletano is Senior Economist at OFCE-Sciences Po, in Sophia- Antipolis, France. He received his PhD in Economics from Scuola Superiore Sant’Anna in Pisa. His research interests include agent-based computational eco- nomics applied to analysis of macroeconomic policies and of financial markets, the analysis of economic networks, and industrial dynamics. He has participated in several research projects financed by the European Union. His articles have appeared in Journal of Economic Dynamics and Control, Games and Economic Behav- ior, Journal of Applied Econometrics, Journal of Economic Behaviour and Organization, Journal of Evolutionary Economics, Regional Studies, Networks and Heterogeneous Media, and European Physical Journal B. Notes on Contributors xiii

Jonathan D. Ostry is Deputy Director of the Research Department (RES) at the International Monetary Fund. His current responsibilities include leading staff teams on: IMF–FSB Early Warning Exercises on global systemic macrofinancial risks; vulnerabilities exercises for advanced and emerging market countries; mul- tilateral exchange rate surveillance, including the work of CGER, the Fund’s Consultative Group of Exchange Rates, and EBA, the External Balance Assess- ment; international financial architecture and reform of the IMF’s lending toolkit; capital account management (capital controls and prudential tools to manage capital inflows) and financial globalization issues; fiscal sustainability issues; and the nexus between income inequality and economic growth. Past positions include leading the division that produces the IMF’s flagship multilat- eral surveillance publication, the World Economic Outlook, and leading country teams on Australia, Japan, New Zealand and Singapore. He is the author/editor of a number of books on international macro policy issues, and numerous arti- cles in scholarly journals. He holds undergraduate degrees from the University of Oxford (Balliol College) and Queen’s University (Canada), and graduate degrees from the London School of Economics (MSc, 1984) and the University Chicago (PhD, 1988).

Jean-Charles Rochet is Swiss Finance Institute Professor of banking at Zurich University and research associate at the Toulouse School of Economics. He holds a PhD in mathematical economics from Paris University. He has taught at the Toulouse School of Economics, at the London School of Economics, and has visited many universities and central banks all over the world. He was President of the Econometric Society in 2012 and has been a fellow of this society since 1995. He has published more than 80 journal articles and 7 books, including Microeconomics of Banking (1997, with X. Freixas) and Why Are There So Many Banking Crises? (2008). His research interests include banking, financial stability, industrial organization of financial markets, and contract theory.

Andrea Roventini is an associate professor at the Scuola Superiore Sant’Anna, in Pisa. His main research interests include complex system analysis, agent- based computational economics, business cycles, and the study of the effects of monetary, fiscal, technology and climate policies. He has participated in sev- eral projects financed by the European Commission and the US National Science Foundation. His works have been published in the Journal of Applied Economet- rics, Journal of Economic Dynamics and Control, Journal of Evolutionary Economics, Environmental Modelling and Software, and Macroeconomic Dynamics.

Martin Scheffel is an assistant professor at the Centre for Macroeconomic Research, University of Cologne. Prior to this he held positions at the Swiss Fed- eral Institute of Technology (ETH) Zurich and the Centre for European Economic Research (ZEW) Mannheim. He holds a PhD from the University of Mannheim, xiv Notes on Contributors a Masters from Brown University, and a diploma from the University of Heidel- berg. His research is on incomplete market macroeconomics with focus on the banking sector and labor markets.

Joseph E. Stiglitz is University Professor at Columbia University, USA. In 2001 he was awarded the Nobel Prize in Economics for his analyses of markets with asymmetric information. He was the President of the International Economic Association from 2011 to 2014.

Servaas Storm works on income distribution & growth; technology, finance and climate change. He is Senior Lecturer at Delft University of Technology and an editor of Development and Change. His work has appeared in Cambridge Journal of Economics, Development and Change, Eastern Economic Review, Industrial Rela- tions, International Review of Applied Economics, Journal of Development Economics, Journal of Post Keynesian Economics and Structural Change and Economic Dynam- ics. His latest book, co-authored by C.W.M. Naastepad, is Macroeconomics Beyond the NAIRU (2012). It won the 2013 Myrdal Prize of the European Association for Evolutionary Political Economy.

Tania Treibich is a post-doctoral researcher at Maastricht University, The Nether- lands. She received her PhD in Economics from Scuola Superiore Sant’Anna and the University of Nice Sophia Antipolis in 2012. Her general research inter- ests relate to the transmission mechanisms between microeconomic industrial dynamics (investment, innovation and trade) and macroeconomic outcomes and policies (i.e. fiscal and monetary policies). She has investigated these issues using panel data econometrics applied to policy evaluation, agent-based mod- elling and experimental techniques. Her works have been published in the Journal of Economic Dynamics and Control, Small Business Economics, Industrial and Corporate Change, Empirical Economics and Technovation.

A. Erinç Yeldan received his PhD from the University of Minnesota and joined the Department of Economics at Bilkent in 1988. He served as Chair of the Eco- nomics Department between 1998 and 2003. During 1994/95 he was a visiting scholar at the University of Minnesota where he taught applied general equi- librium analysis. He later worked as a research associate at the International Food Policy Research Institute, Washington, DC. During 2007/2008 he was a Fulbright scholar at University of Massachusetts, Amherst and at Amherst Col- lege. His recent work focuses on development macroeconomics and on empirical, dynamic general equilibrium models with emphasis on the Turkish economy. He is one of the executive directors of International Development Economics Associates (IDEAs), New Delhi.