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2011 Nobel Economic Prize Recipients Changed Economic Theory

Today’s announcement of the 2011 Nobel Economics Prize winners should be welcome news to anyone who wants to promote good economics. The award went to two American economists, Drs. Thomas Sargent and Christopher Sims, who developed some of the most important economic models of the 1970s and 80s.

A crucial aspect of modern economics theory is determining whether fluctuations in the economy are caused by policies themselves, or whether causality runs inversely, where expectations of future variance trigger policy changes. Until the 1970s, there was a lack of recognition in mainstream economics that understanding this relationship was crucial to formulating accurate observations. Furthermore, there was no consistent method of distilling it into an empirical tool. Without such a tool, assumptions of prominent models could not be tested and even prominent economic models could often be useless for policy analysis and especially for forecasting.

Sargent and Sims developed quantitative methods of culling useful statistical data from historical sources to determine the role expectations played in economic cause-and-effect. Sims developed an analytical model known as vector autoregression, which sought to explain that the outcome of variables depended on a combination of their own past values, the aggregated past values of other variables, and on exogenous shocks. His continually evolving model is widely used today and directly influenced the development of the New Keynesian economic framework.

Sargent's addition is described by the Nobel Prize committee as "purely methodological." To analyze how long-term structural changes in economic policy affect variables over time, Sims pioneered the use of the rational expectations hypothesis, which allowed for formal statistical modeling of economic theories.

Sargent and Sims' contributions are largely complementary and helped economics become a more credible field. Mainstream progressive economist Paul Krugman described the prize as highly deserved since before the two, "econometrics consisted largely of estimating models you had no good reason to believe based on identifying assumptions" with potentially dubious legitimacy.

To a generation entering the world in ominous times, distrust in our leaders is greater than ever. The most destructive force has undoubtedly been the collapse of the American economy and its ripple effects throughout the world, which has had terrible effects on the discipline's credibility. That is not to say that economists, by and large, do not deserve the criticism. For example, in May 2009, a survey of 45 leading minds in the field predicted the recession would probably end in 2009. Krugman in particular has accused some conservative economists as no longer arguing from a coherent model but "a bunch of prejudices, strung together with some vaguely economistic-sounding phrases."

Economist Robert Shilling claims that one of the biggest problems facing the economy is consumer uncertainty. If everyday citizens, the drivers of the economy, are so worried about their financial future that they restrict spending en masse now, and businesses do not feel comfortable expanding operations and bolstering employment, then any economic recovery will be stalled. Nine years after the Great Depression began, there remained "a sense of ultimate futility" that unemployment would never end. To restore consumer confidence, it is incredibly important to rebuild the economic discipline.

Sargent and Sims' work has immense potential to aid that recovery. The tools they developed became massively powerful ways to assess the outcomes of previous policy decisions. They contributed not only to encouraging more reliable research based on more realistic assumptions, but helped to bolster the defenses of the discipline against bad, unreliable, or poorly developed theories. Although some economists treat their results as authoritative, economics is not a science. Their tools have helped economics become a far less rigid, far more fluid arena. If economics' reputation is faltering, at least this year's Nobel Prize winners are some of the good guys.

However, recognizing the importance of the work done by visionary economists like Sargent and Sims is only part of the solution. The American public must become much more educated in the field. There are few economic "laws" on which Americans must fundamentally agree, but without widespread public comprehension of economic issues, it will not even matter what the economists are saying. A grassroots understanding of even basic aspects of modern economic theory is crucial to prevent knee-jerk ideologues, deliberately manipulative lobbyists, and our increasingly out-of-touch elected officials from utilizing bad economics as smoke and mirrors to prevent voters from holding them accountable for the dismal state of the world's finances.

Photo Credits: NYU Stern and Princeton

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