Nobel prize: Hall and Woodford on economic stabilisation

Robert E Hall of Stanford University and Michael Woodford of Columbia University have shared this year’s Nobel Prize in Economics for “microeconomic foundations of macroeconomic stabilisation”. Stabilisation, here, refers to policy measures by governments and central banks to reduce fluctuations in an economy. A government’s decision to provide a tax break or a central bank choosing to raise or cut interest rates are common examples of such decisions. The contribution of Hall and Woodford is to provide a better understanding of how and when to take decisions for ensuring that an economy does not swing between prolonged periods of slow or stagnant growth and high and persistent inflation.

At the heart of their work is the idea provided by John Maynard Keynes: That governments can intervene and help reduce fluctuations in an economy. Keynes’s insight helped economies learn from the Great Depression. For a while, his recipe seemed to work quite well: Whenever an economy started to slow down, policymakers intervened by cutting taxes and interest rates to boost growth, and when an economy experienced high inflation, interest rates were cut. But the repeated oil price shocks during the 1970s saw many economies, especially the US, witness high unemployment and high inflation both at once. The Keynes remedy failed to provide a solution and, in fact, many started seeing government intervention as the problem, not the solution.

Hall and Woodford’s work has demonstrated “how economic models could be reconstructed to revitalise stabilisation policy”. They studied how individuals made their consumption decisions (Hall) and how businesses fixed prices (Woodford) — covering the demand and supply sides of the puzzle — to provide a more robust understanding. This has helped governments across the world avoid mistakes of the past.