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Are Josephus and other ancient writings considered historically sound or does the fact that his numbers are sometimes overly inflated to aggrandize his fellow countrymen make it a source of questionable validity and reliability?
Essentially, what are the limitations when using such an ancient text when looking for legitimate historical information?
While a healthy dose of scepticism is warranted when reading any historical text, there are several things in particular to be wary of when dealing with ancient sources. One of them, as you say, is exaggerated numbers. Geography is also suspect owing to poor measurements and traditional beliefs. Probably the most notorious is the quoting of speeches which are "required by the occasion" (ie. made up by the historian but hopefully reflective of what was likely in that situation).
In the introduction to the Penguin Classics publication of G. A. Williamson's translation of the Jewish War by Josephus, E. Mary Smallwood criticises Josephus for making exaggerations for dramatic effect and for overuse of speeches, some of excessive length and implausibility. She also criticises his inconsistencies, the undue weight he attaches to minor issues and his attraction to incredible accounts.
Because Josephus is our sole source of information for many of the topics that he covers, we can not afford to treat him as an illegitimate source. However, the inability to compare his accounts with those of others means that we can not know exactly to what extent his personal biases coloured his history writing, and this, coupled with his obvious deficiencies, means that he needs to be read with care.
