Two U.S. economists, Robert E. Hall and Michael Woodford, have been awarded the Nobel Prize for Economic Sciences for their work on the role of household and business expectations in providing the foundations for economic stability.
Hall is a professor of economics at Stanford University, while Woodford holds the same position at Columbia University. The 12 million Swedish kronor prize, equivalent to roughly $1.3 million, will be shared equally.
Policies first proposed by John Maynard Keynes in the 1930s to stabilize the economy when it is either running too cold or too hot were effective until the 1970s, when they proved unable to respond to a series of energy shocks.
The Nobel organization said the work of Hall and Woodford helped to provide a framework for understanding why those policies failed, and emphasized the importance for governments and central banks of communicating clearly with households and businesses about their plans and their reasons for intervening.
"The understanding of the people making decisions about spending, their expectations of what policy is likely to be like in the future is crucial to the effects of policy," Woodford said.
The Nobel committee highlighted Woodford's 2003 book "Interest and Prices: Foundations of a Theory of Monetary Policy" as the key work that outlined the new framework founded on his research and that of Hall.
"I'm elated, " Woodford said. "It's a tremendous honor, it's a surprise."
One key example of the new approach is the use of forward guidance by central banks, in which they offer businesses and households a clear understanding of how interest rates are likely to change in the future.
Forward guidance was widely adopted by central banks following the global financial crisis, when their key rates had already been lowered to zero and further stimulus was needed to avoid a slide into deflation.
By assuring households and businesses that borrowing costs would remain low for a significant period, central banks hoped to stimulate borrowing for investment.
"Making more explicit statements about the likely future path of interest-rate policy was an important part of the response in the years from 2009 onward and I think it did contribute to better stabilization," Woodford said.
However, that form of forward guidance has fallen out of favor in the changed circumstances facing policymakers in the 2020s, where the global economy has been buffeted by a series of supply shocks that make it difficult to make even tentative commitments about the future rate path.
Federal Reserve Chairman Kevin Warsh is a critic of the continued use of forward guidance, and has put aside the tools his predecessors used to steer expectations.
However, the work of Hall and Woodford also emphasizes the importance of credibility for the success of central bank and government policies, which has relevance to the surge in energy prices since the outbreak of war in the Middle East, and previous shocks such as the Covid-19 pandemic and Russia's 2022 invasion of Ukraine.
Their work suggests that if they believe central banks will raise their key interest rates sharply enough to tame an inflation burst, households and businesses are less likely to behave in ways that reinforce the move in prices.
"The laureates' work has provided us with a stable theoretical foundation for the models that are now used by central banks and governments around the world," said John Hassler, a professor of economics at Stockholm University who was a member of the committee that awarded the prize. "With them, we are better equipped to deal with shocks in the economy, such as energy crises or sudden changes in how much households consume."