Thomas Sargent of New York University and Christopher Sims of Princeton University are the proud recipients of the Nobel Prize in the Economic Sciences for 2011. Their work in structural macroeconomics seeks to explain the impact of policy decisions, such as a tax cut or a hike in interest rate, on economic growth and inflation. While Professor Sargent’s work focuses on the long-term impacts of such policy decisions, Professor Sims’ work deals with understanding the nature of “shocks”, which by their very nature are sudden. By orientation, Professor Sargent is a pure theorist, while Professor Sims’ work is more applied, which makes their respective work complementary. There is no denying their seminal contribution to economics.
The award to Professor Sargent is a reiteration of the continuing respect the “rational expectations” school, of which Professor Sargent was an important pioneer, commands. In recent years, three other rational expectations theorists, Robert Lucas, Edward Prescott and Finn Kydland, have been awarded the Nobel Prize for highlighting the role of expectations in economic policy making. The central tenet of rational expectations is that economic stakeholders anticipate government actions and structure their responses accordingly. This in turn allows the government to manipulate the economy through policy decisions. For example, an anticipated increase in tax rates will automatically lead consumers and households to reduce expenditure, given lower disposable incomes that would follow as a consequence. Professor Sargent’s notable contribution has been to provide a rigorous theoretical and mathematical foundation for this economic intuition. Much of his work is contained in Dynamic Macroeconomics (Harvard University Press, 1987), a standard text book in doctoral programmes in the US.
Despite being a prolific contributor to macroeconomic theory and policy, Professor Sims is best remembered for pioneering the Vector Auto Regression (VAR) model, which was essentially a less cumbersome computational technique compared to multi-equation models, which dominated until the 1970s. The seminal contribution of this method is that it provided a clear understanding of the role predictors with a lag played in explaining the variable of interest. An example of the utility of VAR would be in the study of the dynamic behaviour of the commodities market, where variables like price, production and inventory levels were explained in terms of lagged values of predictors like income and weather. Professor Sims’ contributions were primarily in evaluating the effects of short-term shocks (for example, a sudden like in oil prices) and more importantly how elastic the response of the system would be in recovering from such shocks. This was an important step forward because it gave policy makers an idea of how long recovery would take and enabled them to respond accordingly. Professor Sims’ work in the area of fiscal and monetary economics is both far-reaching and visionary. For example, along with Martin Feldstein, he was among the first scholars to question the viability of the European Monetary Union without the fiscal consolidation to accompany monetary grouping. The very nature of the current financial crisis, deeper and longer, ironically places limitations on the policy prescriptions that emerge from Professors Sargent and Sims’ work. It does not, however, diminish the towering contributions they have made to enrich the field of modern economics.