Nobel Economics Prize Goes to Hall and Woodford for Reworking Keynes

Americans Robert E. Hall of Stanford University and Michael Woodford of Columbia University won the Nobel Memorial Prize in economic sciences on Monday for research that rebuilt the theoretical foundations of how governments and central banks manage shocks such as energy crises and inflation. The prize is worth 11 million Swedish kronor (about $1.2 million) and was announced by the Royal Swedish Academy of Sciences in Stockholm.

"The laureates' research has made it possible to manage major macroeconomic crises far more effectively than before," the Nobel committee wrote. "It has been hugely beneficial during the pandemic and the energy crises of recent years."

Reached by phone from New York during the broadcast announcement, Woodford said: "It's a tremendous honor. It's a surprise."

What did the laureates change?

For decades, policymakers answered downturns with the Depression-era prescriptions of John Maynard Keynes: cut interest rates and taxes, raise government spending, and wait for consumers and businesses to restart growth.

"This is the Keynesian recipe and it worked well — until it didn't," said Timo Boppart of the Nobel economics committee.

The stagflation of the 1970s — simultaneous high inflation and high unemployment — broke the old assumptions that economic management involved simple trade-offs between the two. Hall and Woodford, in separate contributions, rebuilt the Keynesian framework around how households and firms actually decide whether to spend, save, invest or set prices.

"Economic outcomes are the result of millions of decisions made at the microlevel by households and businesses," the committee wrote. Their approach, rather than studying the economy "like a bird's eye view," "generated a paradigm shift in the theory of stabilization policy."

What did Hall find about consumers?

Hall showed that spending decisions hinge on what consumers expect their future income to be. "If they are optimistic, they will consume more than if they are pessimistic," the committee wrote. Because expectations shift with unexpected news, Hall concluded that forecasting future consumer spending is virtually impossible.

"This is not good news for forecasters, or policymakers," said Olivier Blanchard, chief economist at the International Monetary Fund during the 2008 financial crisis. "But it is news they must take into account in thinking about the effects of policy."

In a 1982 paper co-written with economist Fredric Mishkin, Hall found roughly 80% of households based spending on expectations for the future, "while the rest lived hand to mouth."

"The prize is for research that pushes our understanding of macroeconomics from the bottom up, from families and firms making decisions over time, while looking ahead," said Ivan Werning, an economist at the Massachusetts Institute of Technology.

How does Woodford's work shape the Fed?

Woodford established that businesses set prices based on where they believe interest rates — and competitors' prices and their own costs — are heading. That finding pushed central banks toward what became known as "forward guidance": explaining their reasoning and plans clearly so markets and firms can form accurate expectations.

The practice now faces pushback at the top of the U.S. Federal Reserve. Kevin Warsh, the new Fed chair, has said forward guidance went too far and is scaling back how much the central bank talks about its intentions — a direct test of the communication doctrine Woodford's research inspired.

Woodford's models also addressed energy price shocks, like the one that followed the U.S. and Israeli attack on Iran in February, which can stoke inflation and unemployment at once. "Unlike the traditional Keynesian models, Woodford's model recommends a cooling measure, such as increased interest rates, to avoid uncontrolled inflation," the committee wrote. "His insight has made it possible to respond to recent supply shocks more effectively than during the oil crises of the 1970s."

Woodford said his work has stressed "the understanding of the people who are in the markets and making decisions about spending."

Why this award matters now

The economics prize, formally the Bank of Sweden Prize in Economic Sciences in Memory of Alfred Nobel, was established in 1968 and closes out this year's Nobel announcements, which last week honored medicine, physics, chemistry, literature and peace. Hall's win marks the second Stanford Nobel this year, after Dr. Karl Deisseroth shared the medicine prize. The award will be presented Dec. 10, the anniversary of Alfred Nobel's death — and it lands as Warsh's Fed begins rolling back the very communication practices the laureates' research helped create.