Chapter

The Financial Crisis of 2007–8 and its Macroeconomic Consequences<sup>1</sup>

Joseph E. Stiglitz

in Time for a Visible Hand

Published in print January 2010 | ISBN: 9780199578801
Published online February 2010 | e-ISBN: 9780191723285 | DOI: http://dx.doi.org/10.1093/acprof:oso/9780199578801.003.0002

Series: Initiative for Policy Dialogue

The Financial Crisis of 2007–8 and its Macroeconomic Consequences1

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The global financial crisis is distinctive in its origins, its magnitude, and its consequences. This chapter examines the failures that led to the crisis and, in particular, the important role played by information and incentives problems. On the basis of this diagnosis, the author provides recommendations on how to reform financial regulation to prevent future crises. The crisis provides an excellent case study in the economics of information. Stiglitz illustrates how the models—those used explicitly by or implicit in the mind of both regulators and market participants—ignored the imperfections and asymmetries of information. Since incentives mattered, distorted incentives at both the individual and organizational level led to distorted behavior. These distorted incentives included executive compensation systems in banks and conflict of interest in rating agencies. Additional problems were caused by the repeal of Glass‐Steagall, moral hazard, the use of complexity to reduce competition and increase profit margins, as well as moral hazard problems created by securitization.

Keywords: regulatory instruments; incentives; asymmetries of information; modeling; transparency; executive compensation

Chapter.  14680 words. 

Subjects: Macroeconomics and Monetary Economics

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