American economists Robert E. Hall ( Robert E . Hall ) and Michael Woodford ( Michael Woodford ) were awarded the Nobel Memorial Prize in Economic Sciences on Monday, in recognition of their work in model research that has helped governments and central banks around the world manage economic shocks such as energy crises and inflation.

The Royal Swedish Academy of Sciences announced the winners in Stockholm, stating that the research of these two individuals has established a theoretical foundation that enables people to better understand how consumers decide whether to save or consume. These insights also make it easier for policymakers around the world to stabilize economies after economic fluctuations.

In a document explaining the work of the two economists, the Nobel Committee wrote: “The laureates’ research has made managing major macroeconomic crises much more effective than in the past.” The committee also stated: “During the pandemic and the recent energy crisis, this research has brought tremendous benefits.”

Hall is affiliated with Stanford University in California, while Woodford is affiliated with Columbia University in New York.

Woodford said to the committee over the phone from New York, "It is a great honor and also quite unexpected."

Two individuals overturned the earlier economic assumptions.

For decades, when governments around the world have faced economic shocks, they have typically followed the approach proposed by British economist John Maynard Keynes ( John Maynard Keynes ) during the Great Depression: intervening in the economy through interest rate cuts, tax reductions, and increased government spending, thereby encouraging consumers and businesses to spend and invest, and helping the economy to grow again.

Timo Boppat, a member of the Nobel Committee in Economic Sciences ( Timo Boppart ), said: "This is the Keynesian formula, and it has always worked well – until it stopped working."

Policymakers used to believe that economic management involved simple trade-offs – for example, during periods of high inflation, unemployment rates would remain low, and when inflation decreased, unemployment rates would rise. However, the ‘stagflation’ of the 1970s – a situation where the global economy experienced both high inflation and high unemployment rates simultaneously – proved that this formula was too simplistic.

Some economists believe that government attempts to intervene in the economy are doomed to fail. However, Hall and Woodford have each improved the Keynesian model from different perspectives, taking into account how consumers and businesses actually decide on investment and spending.

The Nobel Committee wrote, “Economic outcomes are shaped by millions of decisions made at the micro level by households and firms.” The committee stated that by using models based on this approach, rather than observing the economy from a macroscopic perspective as if from above, Hall and Woodford’s research “has brought about a paradigm shift in the theory of stable policies.”

Hall studies consumer choices

Hall studied whether and to what extent consumers' spending depends on their expectations of future income.

The committee wrote, “If they are optimistic, consumption will be higher than when they are pessimistic.” However, as new information about the economy emerges, consumers’ expectations may change unexpectedly. Hall found that it is almost impossible to predict future consumer spending.

Olivier Blanchard ( Olivier Blanchard ), who served as the Chief Economist of the International Monetary Fund during the 2008 financial crisis, stated in an email that the view that consumption is largely unpredictable "is not good news for either forecasters or policymakers," but "it is information that they must take into consideration when thinking about the impact of policies."

Hall also studied a situation where some families were in such financial distress that they were unable to borrow money or draw on their savings during economic changes. The Nobel Committee wrote that in a paper co-authored with economist Frederic Mishkin in 1982, Hall found that about 80% of families decided their spending based on their expectations for the future, “while the remaining families barely managed to get by.”

Ivan Werning, an economist at the Massachusetts Institute of Technology ( Ivan Werning ), stated in an email: “This award recognizes a type of research that promotes our understanding of macroeconomics from the bottom up, that is, starting from the decisions made by households and businesses over time and looking forward from there.”

Woodford analyzes how businesses make decisions

Woodford's research indicates that when setting prices, companies make decisions based on how they expect interest rates to change in the future.

The Nobel Committee writes: “If a company believes that both its competitors’ prices and its own costs will rise, then it is best for it to set its price higher than it would under the opposite expectation.” Therefore, corporate decisions are also driven by expectations.

Therefore, central banks that set short-term interest rates, such as the Federal Reserve Board of the United States ( Federal Reserve ), should provide "clear and credible communication about their thinking and plans." Central banks have responded to this insight by making greater efforts to explain their actions.

The new Federal Reserve Chairman, Kevin Warsh ( Kevin Warsh ), stated that this trend of "forward guidance" ( forward guidance ) has gone too far. He is attempting to reduce the extent to which the central bank communicates about its own thoughts and intentions.

Woodford's research also provides guidance for central banks on how to respond to energy price shocks, such as the one that occurred after the attacks on Iran by the United States and Israel in February. Such shocks can either drive up inflation or lead to an increase in unemployment rates.

The Nobel Committee wrote: "Unlike the traditional Keynesian model, Woodford's model suggests taking cooling measures, such as raising interest rates, to prevent inflation from getting out of control. His insights have made it more effective to deal with recent supply shocks than during the oil crisis of the 1970s."

In a telephone interview broadcast during the press conference, Woodford stated that his research emphasizes "understanding the people in the market, as well as those who make spending decisions."

The Nobel Prize in Economics is the last Nobel award to be announced this year.

The official name of the Economics Prize is the “Sveriges Riksbank Prize in Memory of Alfred Nobel in Economic Sciences.” The Sveriges Riksbank established this prize in 1968 to honor Alfred Nobel, a Swedish businessman and chemist from the 19th century who invented dynamite and established the five Nobel Prizes.

Nobel purists emphasize that, technically, the Economics Prize does not belong to the Nobel Prizes, but it is always awarded on December 10th along with the other prizes. This day marks the anniversary of Nobel's death in 1896.

The Nobel Prizes were announced last week for Medicine, Physics, Chemistry, Literature, and Peace.

The award on Monday was the second Nobel Prize of the year for a professor from Stanford University. Karl Deisseroth ( Dr . Karl Deisseroth ), along with Peter Hegemann ( Peter Hegemann ) and Georg Nagel ( Georg Nagel ), were jointly awarded the Nobel Prize in Medicine in recognition of their work that has led to the development of a tool that uses light to help reveal how the brain functions.

This year's prize money is 12 million Swedish kronor, which is approximately 1.2 million US dollars. The amount is the same regardless of whether the winner is an individual, a small group of winners, or an organization.

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Reported from Berlin by Dazio ( Dazio ), and from Washington by Wiseman ( Wiseman ). Associated Press reporter Wyatt Grantham-Phillips ( Wyatte Grantham - Philips ) contributed to this report from Chicago.

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