David R. Henderson  

Henderson on Sargent and Sims Nobel

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"A Nobel for Non-Keynesians," my piece on the Nobel prize winners, Thomas J. Sargent and Christopher A. Sims, ran in the Wall Street Journal today. I wrote it yesterday a.m., which is why I didn't take time to post on it yesterday. Suffice it to say that I strongly disagree with Arnold's dismissal. Here is a long excerpt, followed by a paragraph the editors cut. The excerpt is on Sargent, the person whose work I know best. By the way, he wrote the entry on Rational Expectations for the first edition of The Concise Encyclopedia of Economics.


This conclusion was at odds with the Keynesian model, which dominated economic thinking from the late 1930s to the early 1970s. The Keynesian model posited a stable trade-off between inflation and unemployment. In 1970, major U.S. econometric models, built on Keynesian assumptions, predicted that the government could get the unemployment rate down to 4% if it accepted an increase in inflation to 4%. In a 1977 article titled "Is Keynesian Economics a Dead End?" Mr. Sargent wrote, "[I]nstead of 4-4, in the mid-1970s we got 9-9, a very improbable occurrence if econometric models of 1969 had been correct."

In his later work, Mr. Sargent explored expectations in other contexts. An important one is the issue of how a government can end high inflation. Mr. Sargent studied four countries that had hyperinflation in the early 1920s--Germany, Austria, Hungary and Poland. All used inflation to finance high government deficits. They all succeeded in eliminating hyperinflation, but to do so they had to be credible. Of course, they got rid of their old currencies and started new ones. But they also had to affect people's expectations by committing to substantially lower budget deficits. All four governments did.

Although the Nobel committee did not cite his work on unemployment insurance, Mr. Sargent, with Swedish economist Lars Ljungqvist, found that high, long-lasting unemployment benefits in Europe have caused many European workers who lose their jobs to stay unemployed for years and, thereby, erode their "human capital." This makes them less employable in the long run. The fact that the U.S. government has extended unemployment benefits in many U.S. states to 99 weeks, said Mr. Sargent in a 2010 interview with the Federal Reserve Bank of Minneapolis, "fills me with dread."

The interview linked to above is the single best popular piece for getting to know the sharpness of Sargent's thinking. I had already been impressed by Sargent. Reading some of his work yesterday deepened that impression.

In fact, it was based on that interview that I wrote this paragraph, which got deleted:

Sargent is actually quite ecumenical. In the same interview, Sargent praises articles by left-wing economists Joseph Stiglitz and Jeffrey Sachs. Stiglitz and Sachs, he points out, "executed a rational expectations calculation to compute the rewards to prospective buyers" of "toxic assets" under President Obama's Public-Private Investment Program of 2009. "Those calculations," says Sargent, "showed that the administration's proposal represented a large transfer of taxpayer funds to owners of toxic assets."

HT for help with understanding Sims to Alex Tabarrok and Tyler Cowen.

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COMMENTS (5 to date)
Eric Falkenstein writes:

Stiglitz said Geithner's PPIP bank plan was a massive give away to banks and the investors in the plan. His example suggested a 54% return to investors, a -40% return to government. If true, you would expect a stampede of investors.

By revealed preference, this was untrue; banks avoided it, PPIP went nowhere. Stiglitz, obviously, was wrong. Sargent should have known this by the time of that interview.

Daniel Kuehn writes:

I agree with your praise of Sargent and Sims, but how do you square your op-ed's lede with the fact Keynesians have readily embraced precisely these concerns about both expectations and empirical macroeconomics?

I see Sargent, Sims, Lucas, etc. as critiquing a naive way of doing formal econometric modeling. Once could use those naive methods to do formal modeling of any theoretical tradition - it just so happens that Keynesianism was ascendant at the time of this early growth in data collection and econometric work. A better lede would have been "A Non-Cowles Nobel" that Keynesianism was flourishing in the midst of all that seems more incidental to me.

That's not to say Sargent is some kind of stealth Keynesian. It's just to say (1.) they killed the old modeling method, not Keynesianism, (2.) Keynesianism has done great under their new methods, and (3.) that Keynesianism is even part of this discussion is something of a historical accident.

John Goodman writes:

Nice piece in the Wall Street Journal today.

Scoop writes:

I don't know enough to have my own opinion on the importance of their work, but just to have a bit of fun arguing Arnold's point indirectly:

Could these guys really be so earth-shakingly important if you had to quickly research their research when you heard they'd won? Given that you know something about economics, wouldn't you have known the contributions of truly major figures off the top of your head? I have to look up the lifetime figures for Andre Dawson but I'm pretty clear about the accomplishments of Willie Mays.

David R. Henderson writes:

@Eric Falkenstein,
Thanks. Maybe that’s why the Journal cut that paragraph. :-)

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