Monday, October 10, 2011

The Economics Nobel

Goes to Chris Simms and Tom Sargent. From the Nobel announcement:

The art of distinguishing between cause and effect in the macroeconomy

How are GDP and inflation affected by a temporary increase in the interest rate or a tax cut? What happens if a central bank makes a permanent change in its inflation target or a government modifies its objective for budgetary balance? This year’s Laureates in economic sciences, Thomas J. Sargent and Christopher A. Sims, have developed methods for answering these and many other questions regarding the causal relationship between economic policy and different macroeconomic variables such as GDP, inflation, employment and investments.

The economy is constantly affected by unanticipated events. The price of oil rises unexpectedly, the cen- tral bank sets an interest rate unforeseen by borrowers and lenders, or household consumption suddenly declines. Such unexpected occurrences are usually called shocks. The economy is also affected by more long- run changes, such as a shift in monetary policy towards stricter disinflationary measures or fiscal policy with more stringent budget rules. One of the main tasks of macroeconomic research is to comprehend how both shocks and systematic policy shifts affect macroeconomic variables in the short and long run. Sargent’s and Sims’s awarded research contributions have been indispensable to this work. Sargent has pri- marily helped us understand the effects of systematic policy shifts, while Sims has focused on how shocks spread throughout the economy.

Being primarily a microeconomist I don't regularly interact with their work. However, I learned the technique of overlapping generations in dynamic models (which I still use all the time) from Sargent's book, and in my limited time-series econometrics training, Sims' vector autoregression was probably the most important and useful tool.

And there is already a lot of fighting about whether this is a freshwater (rational expectations - Chicago and Minnesota) or a saltwater (new Keynesian - Cambridge and Berkeley) prize.  I think it is explicitly neither. Neither of the economists was wedded to a particular camp and what might distinguish them is a search for truth without philosophy.  Perhaps this is the message the Nobel committee is sending.

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