A Nobel for shocks

Models of macro management are being tested

This year’s Nobel Prize in economics has gone to Robert E Hall and Michael Woodford, of Stanford and Columbia Universities, respectively. They are prominent members of the New Keynesian field in macroeconomics, which studies how macroeconomic dynamics — inflation, for example — can be understood in the real structure of the economy. In particular, they have contributed to the study of stabilisation — how central banks and governments can respond to various economic fluctuations, such as business cycles and shocks.

 

As with almost all recent Nobel Prizes in economics, the timing of the award is part of the story. The field of work for which Professors Hall and Woodford are being honoured emerged in the 1970s, a time when the rise in oil prices challenged economic theory, launched stagflation across the world, and caused great public discontent. In recognising the impact of the work that responded to that moment of disorder — launching, in part, the decades of moderation that followed — the Nobel committee is implicitly throwing out a challenge to those who work on macroeconomics today. Is it possible, perhaps, that these ongoing moments of disruption — the return of economic nationalism, geopolitical shocks to fuel and food prices, the increasing concern that chokepoints could squeeze trade — might produce the next great advances in stabilisation theory.

 

It should be noted that many of the assumptions on which Professors Woodford and Hall worked — or, perhaps, helped create a consensus around — are themselves being challenged. The notion that an independent central bank can be charged with stabilising the economy, and that this should be taken out of the executive’s hands, is a relatively recent phenomenon — and one that responds to the experience of the 1970s and the theoretical work that grew out of it. But independence can no longer be taken as a given. The President of the United States (US), for example, has clearly sought to bring the US Federal Reserve to heel. Over in Europe, the leading leftist candidate for the French presidency has threatened to jail the head of its central bank for treason.

 

Broader questions must also be asked about the very nature of “stabilisation”. It often presupposes that shocks are temporary, or that perturbations are part of a business cycle, and that some normal equilibrium can be returned to. But what if the shocks are not transitional? How should macroeconomic stabilisation work under such circumstances? The oil-price shock itself, it should be recalled, was never really reversed; prices settled at a new, permanently higher level. But what if the new normal is not a stable higher price — but erratic, with an upward trend? And how can theory respond to the shifts inherent in the energy transition — or the even greater possible impacts of the technological transition that the growth of artificial intelligence might bring in its wake?

 

Even if these answers are not immediately available, what should be clear is that the age of Neo-Keynesianism, one in which technocrats could use a well-defined toolbox to deal with relatively predictable peaks and troughs, is past. The global economy is facing stresses greater than any it has seen since the Second World War; and macroeconomic tools and the theory that informs them have to be transformed to match the moment. What is important, however, is that this transformation be grounded in a sensible understanding of the microeconomics of production, consumption, and investment. This, in the end, was what Professors Woodford and Hall contributed, and that insight is timeless.