American economists Sargent and Sims share the Nobel Prize

The news is here. They are awarded the prize for their work on evaluating the effect of policy changes on the economy.

Here is a piece of interview with Dr. Sargent. He talked about how macroeconomists use mathematics and statistics methods to construct models and put forward suggestions for policy makers. He also talked about why he thought the generous unemployment compensation in Europe contributed a lot to Europe’s persistent high unemployment. The following words are insightful:

It is true that modern macroeconomists use mathematics and statistics to understand behavior in situations where there is uncertainty about how the future will unfold from the past. But a rule of thumb is that the more dynamic, uncertain and ambiguous is the economic environment that you seek to model, the more you’re going to have to roll up your sleeves, and learn and use some math.

To study the dynamics of the economy, we have to build up quantitative models to systematically examine people’s behaviors and the change in the state of economy. But there is always a limit with the model, as is with anything that human beings make up.

Dr. Sargent was questioned whether the assumptions of macroeconomics need restoration and whether behavioral science should be emphasized. This reminds me of a dialogue with Nobel Laureate Venon Smith at Chapman University, organized by HKU last month. Dr. Smith is an expert in behavioral economics. When he was asked whether we could model people’s behavior in macro terms, he said that we have to design a complicated enough system to do that.

Regarding people’s behavioral effect on the economy, two examples come to my mind. One is when setting the inflation target, the central bank will have to take people’s expectation into account. This means that promising zero inflation rate is not the optimal choice for the economy. Another example is the bank run, which Dr. Sargent also mentioned in the interview.

Economists hardly agree. The fascination of economics is that you always have some puzzle to address or to solve.

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