Sargent and Sims

I’m a little late getting to this (by standards of cyberspace time anyway), but I wanted to comment on Monday’s announcement about the Nobel prize in economics.

NYU Professor Thomas Sargent and Princeton Professor Christopher Sims were justly recognized for their contributions to characterizing dynamic relations between economic variables. For concreteness, let me give an example of what I mean by “dynamic relations.” We’ve observed that when monetary policy becomes looser, GDP will often temporarily grow a little faster. But these responses don’t happen instantaneously, and they don’t last forever. A key question economists would like to ask is how big these effects are and how they unfold over time.

Prior to Sargent and Sims, there was a great deal that was ad hoc about the way economists would approach these questions. What I would characterize as Sims’ greatest contribution is noting that it is possible to summarize the key facts about these relations without having to believe in what he referred to in his 1980 paper Macroeconomics and Reality as “the discouraging baggage of standard, but incredible, assumptions macroeconometricians” had been used to making. Sims suggested that we should always begin with straightforward and completely objective forecasting questions, such as, if I learned that the Fed is setting a lower interest rate this month than I had been expecting, how should that cause me to revise my forecast of what GDP growth is going to be 1, 2, and 3 quarters from now? Sims developed the objective tools we can use for answering those questions that do not depend on my ideological biases or preconceived theories. He suggested that the answers that such an objective analysis produces should be recognized as the basic facts that any model needs to be able to explain. This was a radical step in the direction of transforming macroeconomics into a much more objective, scientific inquiry, and is part of the bedrock of the discipline these days. We still have quite a ways to go in terms of achieving this goal, but owe a great debt to Sims for helping to steer us onto the right track.

Sargent made parallel contributions in terms of economic theory, developing the basic tools needed to extend theory itself to studying questions about what these dynamic relations should look like. If a sensible business planner knows that these effects are going to take time to develop, how should that affect your decisions today, and how does your behavior then feed back into determining the dynamic effects of the policy itself? This is such a fundamental aspect of modern macroeconomics, it’s almost hard to imagine that it was not always the case. But Sargent was very much at the forefront of showing just how it could be done. And although they worked on separate aspects of understanding dynamic economic relations, I think it’s a great choice to honor Sargent’s and Sims’ contributions together.

Congratulations to a couple of the giants on whose shoulders we stand today.

This post originally appeared at Econbrowser and is reproduced with permission.