American Elephants

A Nobel for Economists Thomas Sargent and Christopher Sims by The Elephant's Child

The Nobel Prize for Economics was anounced today.  It goes to Professor Thomas Sargent of New York University, and Christopher A. Sims of Princeton.  An interview of Professor Sargent by the Minneapolis Fed in August 2010 summed up some of his contributions.

Sargent and colleagues at the University of Minnesota rebuilt macroeconomic theory from its basic assumptions and micro-level foundations to its broadest predictions and policy prescriptions.

This “rational expectations revolution,” as it was later termed, fundamentally changed the theory and practice of macroeconomics. Prior models had assumed that people respond passively to changes in fiscal and monetary policy; in rational expectations models, people behave strategically, not robotically. The new theory recognized that people look to the future, anticipate how governments and markets will act, and then behave accordingly in ways they believe will improve their lives.

Therefore, the theory showed, policymakers can’t manipulate the economy by systematically “tricking” people with policy surprises. Central banks, for example, can’t permanently lower unemployment by easing monetary policy, as Sargent demonstrated with Neil Wallace, because people will (rationally) anticipate higher future inflation and will (strategically) insist on higher wages for their labor and higher interest rates for their capital.

Reason has an article that includes Professor Sargent’s skeptical opinion of President Obama’s stimulus, and the problems of Europe’s generous unemployment compensation schemes.  And the New York Sun has another telling why Sergeant described the Stimulus package as “surprisingly naive.”

It is an interesting interview, long but worth it. If you keep stubbornly reading economics, over time, you understand a lot more. As Ira Stoll, who wrote both articles said:

No matter how skeptical one is of the authority of “experts,” it’s hard to avoid paying at least some attention to the people who award the Nobel prize — especially when they give one to someone who tends to support some things one tended to believe already.

Christopher Sim’s work, also awarded for “empirical research on cause and effect in the macroeconomy.” Professor Sims big contribution was to use a statistical tool, the vector autoregression to model the macroeconomy and make macro forecasts. He has written that the macroeconometric models rested on “incredible” assumptions.

This post has been substantially  altered because the early information I saw left out Professor Sims, who shares the prize with Professor Sargent.  Both Nobel recipients drive substantial holes in Keynesian theory. I can’t say much about vector autoregression because that’s way beyond my  understanding of macroeconomics. Congratulations to both.

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