Two economists known for their work on distinguishing cause and effect in the economy have won the 2011 economics prize in memory of Alfred Nobel, in a bold decision which will be seen as honouring academics whose work many blame as partly responsible for the financial crisis.
The Royal Swedish Academy of Sciences awarded the Nobel prize to professors Thomas Sargent, of New York University, and Christopher Sims, of Princeton University, in respect of their independent “empirical research on cause and effect in the macroeconomy,” mostly in the 1970s and 1980s.
The citation was specific in honouring the “empirical” or practical rather than theoretical work of both economists, since Prof. Sargent is best known for his work on rational expectations theory, which underpinned the belief that financial markets work efficiently.
Prof. Sargent has long said rational expectations should not be seen as a school of thought, but “a ubiquitous modelling technique used widely throughout economics” which asserts that the way people form expectations of the future are rational and that outcomes are the same – on average – as people’s expectations of them.
Perhaps the main application of rational expectations theory is the efficient market hypothesis which asserts that the price of an asset contains all relevant information and cannot systematically be over-or under valued. It was the belief in this theory that led to the view that the credit bubble before the financial crisis did not exist.
The academy justified its award to Prof. Sargent for both his work developing structural models of the economy and using statistics to solve them. There is no doubt about his influence in economic thinking and it is used in practical economic research worldwide.
But many of his theories, such as the impotence of government economic policy in shaping economic events – because individuals will spot what the government is doing and offset the effects – remain highly controversial and much disputed.
Prof. Sims was awarded his share of the prize for his statistical models underpinning many macro-economic models today. His work also used expectations to underpin its results and “vector autoregression” statistical models. Used widely in setting monetary policy, his work improved the prediction of the effects of policy changes such as interest rate changes on inflation and growth, by cementing the analysis in a rational framework where time lags matter.
The prize committee acknowledged that the two economists worked independently, but noted the “complementary” nature of their approaches.
“The laureates’ seminal work during the 1970s and 1980s has been adopted by both researchers and policy makers throughout the world. Today, the methods developed by Sargent and Sims are essential tools in macroeconomic analysis,” the Academy said.