New York University professors Thomas Sargent and Princeton University professor Christopher Sims won the Nobel economics prize on Monday for research that sheds light on the cause-and-effect relationship between the economy and policy instruments such as interest rates and government spending.
Sargent and Sims — both 68 — carried out their research independently in the 1970s and '80s, but it is highly relevant today as world governments and central banks seek ways to steer their economies away from another recession.
The Royal Swedish Academy of Sciences said the winners have developed methods for answering questions such as how economic growth and inflation are affected by a temporary increase in the interest rate or a tax cut.
"Today, the methods developed by Sargent and Sims are essential tools in macroeconomic analysis," the academy said in its citation.
Sims told a news conference in Stockholm by telephone that he was sleeping when he got the call from the prize committee and that he had not expected to win.
"Actually, at first we were called twice and my wife couldn't find the talk button on the phone so we went back to sleep," he said.
Sims said there was no easy way in which his work could help resolve the current financial turmoil.
"I don't have any simple answer, but I think the methods that I have used and Tom has developed are central to finding our way out of this mess," he added. "I think they point a way to try to unravel why our serious problems develop and new research using these methods may help us lead us out of it."
Asked how he would invest his half of the 10 million kronor ($1.5 million) award given the turbulence of today's financial markets, Sims said: "First thing I'm gonna do is keep it in cash for a while and think."
Sargent told The Associated Press he was surprised by the award, and he hadn't yet thought of how to celebrate it.
"I'm just going to teach my classes. I teach two classes today. I don't know if that's a celebration," he said by phone, preparing his notes for class on a train about to depart from New York to Princeton, where he is teaching macroeconomics this semester.
He didn't think the Nobel would change his life. "I hope not at all. I'm going to work and keep doing what I do. I like what I do," he said.
The academy said Sargent showed how "structural macroeconometrics" can be used to analyze permanent changes in economic policy — a method that can be applied to study how households and firms adjust their expectations concurrently with economic developments.
Sims developed a method based on so-called "vector autoregression" to analyze how the economy is affected by temporary changes in economic policy and other factors, like an increase in the interest rate, the academy said.
"Sargent has primarily helped us understand the effects of systematic policy shifts, while Sims has focused on how shocks spread throughout the economy," the academy said.
The winners developed models to measure the sometimes surprising way that people actually respond to changes in economic policy.
"People form their own ideas about what's going to happen independently of what the economists say is going to happen," said David Warsh, who writes the blog Economic Principles.
Warsh gave a simple example of the kinds of things Sims and Sargent shed light on: Suppose a government imposes a tax on corn to raise more money. Consumers might confound the government's plan by substituting wheat for corn — and causing tax revenue to drop instead of rise.
The winners' use of complicated economic models usually keeps them a step or two removed from the pressing economic and political issues of the day. But Warsh says they contributed to the models being used now to determine whether governments should be cutting deficits or spending more money to lift the economy out of its rut.
And Sargent famously weighed in on the fight against inflation in the early 1980s. Many economists believed it would take years of high interest rates to bring inflation down. But Sargent believed that inflation could be tamed much faster if the Federal Reserve acted decisively enough to break the public's expectations that prices would continue to rise rapidly.
That is basically what happened: Then-Fed Chairman Paul Volcker raised interest rates so quickly and so much that inflation expectations were shattered.
"It is not an exaggeration to say that both Sargent's and Sims' methods are used daily ... in all central banks that I know of in the developed world and at several finance departments too," Nobel committee member Torsten Persson told the AP.
NYU said Sargent is currently an adviser to the Federal Reserve Banks of Minneapolis, San Francisco, and Chicago and as had an ongoing involvement with the National Bureau of Economic Research.
His current work involves developing models to understand persistently high European unemployment rates; using new statistical methods to characterize the changing behavior of the Fed since WWII and the changing responsiveness of the U.S. economy to Fed actions; and applying techniques of robust control from engineering to optimal policy and the study of individual behavior, the university said.
The economics prize capped this year's Nobel announcements. The awards will be handed out on Dec. 10 — the anniversary of prize founder Alfred Nobel's death. The economics prize is not among the original awards established in Nobel's 1895 will, but was created in 1968 by the Swedish central bank in his memory.