Martin Guzman, Joseph Stiglitz
A key objective of modern macroeconomics is to understand, characterise, and provide policy guidance for economic crises. Nevertheless, the standard dynamic stochastic general equilibrium models struggle to account for deep and persistent downturns, such as the 2008 crisis. This column presents a dynamic disequilibrium theory with randomness to provide new insights into these episodes. The framework features incomplete markets, individual heterogeneity, and an evolving economy in which people are constantly learning. In addition to being more realistic, the theory enables the design of policies that will mitigate the frequency of crises and ameliorate their consequences.