The annual award of the Nobel Prize in Economics (technically, since it’s not one of the original Nobel’s, the “Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel”) is always an occasion for a toast here at Adam Smith, Esq., even if a particular year’s winner is someone we disagree with.
This year, fortunately, we can offer warm congratulations to the co-winners, Thomas Sargent of NYU and Christopher Sims of Princeton.
Although they hadn’t worked together on the work the award was given for, they both contributed greatly to the field of “rational expectations” theory, a branch of economics they largely created in the 1970’s. Sims also created a new way of analyzing economic data using a model called vector-autoregression; when asked what help it would be in resolving today’s global economic morass, he responded modestly: “If I had a simple answer to that I would have been spreading it around the world … It requires a lot of slow work looking at data, unfortunately.” Sargent added: “We’re just bookish types that look at numbers and try to figure out what’s going on. We try to experiment in our models before we wreck the world.”
“Rational expectations” may not sound earth-shattering to the laiety, but it stands for the proposition that people (consumers, businesses, and investors) base their behavior on what they expect governmental policymakers to do, particularly in light of the constraints facing those policymakers.
For example, short-term tax cuts or cuts in interest rates–which people expect will expire in due course–scarcely alter long-term behavior at all. More generally, any policy that has an explicit or implicit expiration date (say, price controls, which will collapse of their own intrinsic instability) will fail to secure the intended results, because people see through it. Sargent summed up the theory in an interview with the Minneapolis Fed in August 2010: “Policymakers can’t manipulate the economy by systematically ‘tricking’ people with policy surprises.”
This has more than tangential resonance today, as it argues that short-term spikes in government spending to bounce an economy out of a slump will have limited impact since people rationally expect it to run out.
Christopher Sims
