The Nobel Prize in Economics is for models that allow smoothing economic fluctuations

"This year's Nobel Prize in Economic Sciences has been awarded to United States scientists Robert E. Hall and Michael Woodford "for the microeconomic foundations of macroeconomic stabilization," the awarding committee announced Monday.

The result of these researchers' research is new macroeconomic models that allow us to explain and quantify how stabilization policies affect business cycles.

The models developed by R. E. Hall and M. Woodford have significantly improved the chances of implementing effective stabilization policies, the press release said.

As John Hassler, chairman of the Economic Sciences Prize Committee, noted in his presentation speech, thanks to them, "we are better equipped to deal with economic shocks such as energy crises or sudden changes in household consumption."

These are models that are now used by central banks and finance ministries around the world.

"Laureate research has made it possible to manage major macroeconomic crises much more effectively than before. This has been extremely useful during the pandemic and the energy crises of recent years, which have not had the same long-term consequences for growth and inflation as the critical periods of the 1970s. We have not fallen into a catastrophic economic depression similar to the one that took place in the 1940s. Periods of recession and high inflation have not disappeared, but they are shorter." - indicates the Economic Sciences Prize Committee.

According to models developed by American scientists, timely fiscal and monetary policy measures can mitigate economic ups and downs, she notes.

"Economic development is characterized by a cycle of ups and downs. Timely stimulation or slowdown of the economy can ensure stability and avoid protracted recessions or uncontrolled inflation. Research by R. E. Hall and M. Woodford led to a paradigm shift in stabilization policy," the report states.

Ever since the economist John Maynard Keynes presented his theories nearly a century ago, stabilization policies have become an important tool for managing such fluctuations. During a recession, the economy is stimulated by lowering interest rates and increasing the budget deficit, while slowing down a booming economy requires doing the opposite.

But during the oil crisis of the 1970s, Keynesian models of when and how to apply appropriate measures appeared to no longer work, the awarding committee said in a press release.

They did not help reduce unemployment, but rather led to uncontrolled inflation. Western countries experienced a decade characterized by slow growth, high unemployment and high inflation. Many believed that the stabilization policy had done more harm than good and that it should be abandoned.

R. E. Hall and M. Woodford, instead of building models based on statistical relationships between macroeconomic indicators (for example, inflation, production and consumption), chose to build them on a microeconomic basis. This includes understanding how the actions of all individual households and businesses affect the economy.

An important part of these models is the assumption that households and firms take future prospects into account when making decisions about savings or commodity prices. When governments and central banks announce their economic policy plans, they can influence this view of the future and steer the economy in the right direction.

"Since the introduction of these new models, they have been very helpful in weathering the economic downturns that have hit us," the statement said.

They complemented each other

As Evaldas Stankevičius, Associate Professor of the Faculty of Economics and Business at the Kaunas University of Technology, explains, R. E. Hall's main contribution is related to consumer behavior and their expectations for the future.

in 1978 the scientist showed that people make consumption decisions based not only on current income, but also on what income they expect in the future. This insight is important for economic policy because it helps to understand why, for example, additional government benefits do not always stimulate consumption – if a person is worried about his financial future, he may choose to save the money he receives instead of spending it.

Woodford's research has helped explain how corporate pricing and consumer and business expectations determine the impact of monetary policy on the economy. Because firms cannot always change prices immediately, central bank interest rate decisions affect not only inflation, but also consumption, investment, production, and employment.

The scientist also revealed that central banks can influence the economy not only by changing interest rates, but also by clearly communicating their future decisions. This shapes the expectations of the population, businesses and financial markets, which in turn influence economic decisions.

"The significance of these findings is particularly important in order to control inflation and at the same time avoid a deep economic recession. Too weak  reaction of the central bank can allow inflation to take hold, while an overly strict one can reduce consumption, investments and employment" - points out E. Stankevičius."