Americans win Nobel for studying how expectations affect economics
Two American scholars won the Nobel Memorial Prize in Economic Sciences for their separate research examining cause-and-effect relationships in the economy and how expectations can drive policy decisions and behavior by consumers and businesses.
Thomas J. Sargent of New York University and Christopher A. Sims of Princeton University were praised for analytic methods that have had a significant influence on economists and policymakers.
Their techniques have been used to study the effect of fiscal stimulus programs, such as the controversial Recovery Act of 2009. Their work also has provided the underpinnings of efforts by the Federal Reserve and other central banks to study and manage inflation expectations and monetary policy.
But the work of Sargent and other proponents of the “rational expectations” theory also has been criticized as partly responsible for the financial crisis. The theory is linked to the idea that markets work efficiently, even as Sargent and others have sought to refine the theory by accounting for various uncertainties.
In announcing the prize, the last of the Nobel awards this year, the Royal Swedish Academy of Sciences said Monday that the pioneering work of Sims and Sargent in the 1970s and 1980s had helped policymakers understand how shocks and policy shifts affect the economy in both the short and long runs.
Sargent and Sims, both 68, conducted their research independently, although they spent the early part of their academic careers together at the University of Minnesota. They will share the $1.5-million prize award.
As social science scholars, one of the big challenges they faced was the-chicken-or-the-egg problem — that is, whether policy affects the economy or the other way around.
Because economics experiments are difficult to perform in the real world, the Nobel committee said, “the laureates’ foremost contribution has been to show that causal macroeconomic relationships can indeed be analyzed using historical data, even in cases with two-way relationships.”
In the past, consumers were often seen as passive players, responding after policies were adopted. But Sargent and Sims integrated people’s expectations, creating a more dynamic framework of looking at the economy and where it may be going.
For example, if businesses expect interest rates to rise in the future, they are apt to behave differently than if they think otherwise.
Sargent’s and Sims’ work has had particular relevance to monetary policy. The importance of expectations can be seen in the Fed’s recent announcement that it would keep its benchmark short-term rates near zero until mid-2013. The Fed was aiming to give clarity to individuals, businesses and markets.
Sargent has focused mainly on studying the economic effects of longer-term policy shifts, such as stringent government budgets that are now prevalent in Western nations.
A native of Pasadena who did his undergraduate work at UC Berkeley, Sargent acknowledged that the models based on his research aren’t perfect, saying, “some are quite good, some need improvement.”
Sargent and Sims both received their doctoral degrees from Harvard in 1968.
Sims, who was born in Washington, D.C., told a telephone news conference in Stockholm, where the award was announced, that the methods he and Sargent used and developed “are central for finding our way out of this [economic] mess.”
Sims was reluctant to offer specific prescriptions, but at a news conference at Princeton later Monday, he said he agreed with Fed Chairman Ben S. Bernanke that the central bank’s monetary policy by itself wasn’t enough.
Echoing Bernanke, Sims said Congress and the White House needed to develop fiscal policy that included a credible budget plan to reduce the deficit without doing short-term damage to the still-fragile economy.
“You can use the statistical tools Sims developed to try to pin down how much fiscal policy helped in ending the Great Depression,” said Barry Eichengreen, a professor of economics and political science at UC Berkeley.
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