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The Atlantic Monthly | October 2002

[From "The Roaring Nineties," by Joseph Stiglitz]

Imperfect Information

In recent years economists have begun to question the previously unchallenged notion that the economy had a "natural rate" of unemployment of 6 percent—the rate of unemployment below which inflation would inevitably ensue. This debate had crucial policy implications for the Federal Reserve, which decides how low it should allow joblessness to sink before raising interest rates. Joseph Stiglitz declared in 1996 that he thought perhaps the natural rate was lower than it was generally believed to be—a position that, just a few years later, has gained almost unanimous acceptance ... but, to a White House obsessed with avoiding any hint of dictating policy to the Federal Reserve, this musing verged on insubordination ...

Stiglitz and his antagonists at the Treasury Department all fall under the broad category of moderate liberals—economists who accept the basic premises of the free market, with certain essential limitations. Despite that broad ideological affinity, though, there is a gulf of intellectual proclivity and life experience between them. While the Treasury Department could be considered generally liberal on domestic policy ... it has also advocated staunchly orthodox views on international economics ... The Treasury has not only made the expansion of international trade the cornerstone of Clinton's foreign policy, it has also tended to espouse the view that rapid liberalization is unambiguously good and requires little restraint. While supporting modified Keynesianism at home, that is, the Treasury Department has advocated unbridled laissez-faire abroad.

Stiglitz, by contrast, made his mark by identifying the ways in which the unregulated market does not work. The free market model, in its purest form, assumes that all actors have access to perfect information. Stiglitz's most influential work has begun with the assumption that people often act on imperfect information. If you assume imperfect information, he has found, an unregulated market often will fail to produce an optimal result.

Indeed, Stiglitz's critique lent respectability to the second thoughts of other prestigious, moderately liberal dissenting economists, including Jeffrey Sachs of Harvard [now at Columbia] and Paul Krugman of MIT [now at Princeton]. These economists have come to question whether orthodox austerity measures are always appropriate in the developing world, and, more broadly, to question the American commitment to pure laissez-faire internationalism. The IMF, meanwhile, has admitted to making some mistakes in Asia, although it remains furious at Stiglitz for pointing [them] out so publicly.

— From "Shoeless Joe Stiglitz," by Jonathan Chait, The American Prospect, July-August 1999

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The Atlantic Monthly; October 2002; Imperfect Information; Volume 290, No. 3; 78.