Two Americans were awarded the Nobel prize in economics Monday for their work that helped explain some of the mysteries of how government policy affects the economy.
Thomas J. Sargent of New York University and Christopher A. Sims of Princeton University, both 68, were jointly awarded the $1.5 million prize for work that helped untangle the details of why economies respond the way they do to intervention by central banks or other government authorities.
Their research, conducted separately, helped better explain the importance of people’s expectations for the workings of policy. For example, higher interest rates help reduce inflation not just through traditional channels like slowing down economic growth, but also by shifting peoples’ expectations of what the central bank will do in the future.
The work has particular relevance at a time governments around the world are trying to find tools that will lift their economies out of the deep global downturn that began in 2008.
Sargent’s work frequently bridges mathematical economic analysis with the study of economic history, and one important paper, “Some Unpleasant Monetarist Arithmetic,” argues that the ability of central banks to influence inflation depends crucially on sound public finances. Sargent’s key insight was that government policy does not occur as a “black box,” with people responding to an interest rate increase or tax cut in the same way at all times. Rather, their reaction is shaped in part by what the action says about how the government will behave in the future, and so the same action might have impacts different from those predicted by traditional economic models.
Sims developed a new statistical technique for unpacking the ways policy affects economies, known as “vector auto regressions,” and his predilection for studying economic events as they actually have occurred is in contrast to a popular thread of macroeconomics that is based more purely on theory.
Sims also has studied the interaction between budget deficits and the workings of monetary policy. His “fiscal theory of the price level,” like Sargent’s work, holds that the limits on a government’s ability to issue debt is a key constraint on what monetary policy, as guided by a central bank, is capable of attaining.
The prize, known formally as the Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel, has been awarded since 1968 and honors economists whose work has deepened mankind’s understanding of economic forces.