This year's prize in economic sciences has been awarded to Robert E. Hall and Michael Woodford for developing new macroeconomic models that have significantly improved the ability to implement effective stabilization policy. Their models enable well-timed fiscal and monetary measures to smooth out the economy's peaks and troughs.
Economies are characterized by alternating downturns and upturns. Since the theories of John Maynard Keynes, stabilization policy has been crucial for managing these fluctuations. However, during the oil crises of the 1970s, it seemed the Keynesian models no longer worked, leading to uncontrolled inflation instead of reducing unemployment. This period of "stagflation" led many to believe stabilization policy should be abandoned.
Robert E. Hall and Michael Woodford are recognized for revitalizing stabilization policy by reconstructing these models. Instead of basing them on statistical links between macroeconomic variables, they built them on a "microeconomic foundation." This approach incorporates an understanding of how the forward-looking actions of individual households and businesses collectively affect the economy.
A central component of their models is that households and firms are forward-looking when making decisions about savings or pricing. By clearly communicating their plans for economic policy, governments and central banks can influence this view of the future and steer the economy in the right direction.
John Hassler, Chair of the Committee for the Prize in Economic Sciences, stated, "The laureates’ work has provided us with a stable theoretical foundation for the models that are now used by central banks and governments around the world. With them, we are better equipped to deal with shocks in the economy, such as energy crises or sudden changes in how much households consume."
Source: The Committee for the Prize in Economic Sciences
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