The Nobel economics prize was awarded this morning to two Americans, Thomas J. Sargent of New York University and Christopher A. Sims of Princeton University, for their work in devising methods to assess how policy changes affect the economy. A few links for further reading below.
Over at Marginal Revolution, Alex Tabarrok puts Sargent’s and Sims’s work in the context of debates in the 1970s over the usefulness of econometric models for predicting policy: “If you wanted to understand the effects of a new policy you had to go deeper, you had to model the decision rules of individuals based on deep, invariant or ‘structural’ factors, factors such as how people value labor and leisure, that would not change as policy changed and you had to include in your macro model another deep factor, expectations.” There’s a lot more at the link.
This Minneapolis Fed profile of Sargent has more of an explanation of the “rational expectations revolution,” which assumes that people act strategically to policy shifts: “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.”
On Twitter, NBER economist Justin Wolfers adds a twist: “There will be lots of talk today about rational expectations. But Sims’s recent work has been about our limited ability to process info.”
But what does that mean for our present economic situation? As the Wall Street Journal’s David Wessel reports, “Chris Sims refuses to say what implications his Nobel-winning work has for current policy.” Sargent, on the other hand, has talked about policy quite a bit — see this 2010 interview where he lodges some skepticism about Obama’s stimulus plan and discusses research showing that government safeguards can induce banks to take bigger risks.
If you want to wade deeper into their work, Tyler Cowen has scores of useful links for both Sargent and Sims. One highlight: “Here is Sargent’s take on the history of the Fed; basically the Fed first had an OK model, then forgot it for a while (the 1970s), then relearned it again.”