And the Nobel Prize Goes To...

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Two U.S. economists were yesterday awarded the 2011 Nobel Peace Prize in economic science. Professor Christopher Sims and Thomas Sargent, both 68, were given the highest recognition for their 35-year careers in the fields of macroeconomics and macroeconomic policy making.

According to the Nobel jury, this year's laureates have "developed methods for answering... questions regarding the causal relationship between economic policy and different macroeconomic variables, such as GDP, inflation, employment and investments.”

Sims, who is currently professor of economics at Princeton University, is known for his work on how economies are affected by temporary unexpected shocks, such as spikes in the rate of inflation.

Sargent, who is professor of economics at New York University, has focused on how and to what extent economies are affected by more permanent changes, such as the raising of interest rates by central banks.

Though both men have different research focuses, they have collaborated frequently during their work. Both Sims and Sargent are associated with the “rational choice theory” which holds that economic agents – households and businesses – can adapt and anticipate responses to policy changes. According to this assumption, a critical macroeconomic implication is that government actions (and policy-making) will only have a limited impact and effectiveness.

Sargent's and Sims' work has had particular relevance to monetary policy. The importance of expectations can be seen in the Fed's recent announcement that it would keep its benchmark short-term rates near zero until mid-2013. The Fed was aiming to give clarity to individuals, businesses and markets.

Prof Antoin Murphy of Trinity College Dublin, welcoming the award, described Prof Sargent as having “a very eclectic and questioning mind”, but questioned some of the policy implications of rational choice theory including the very limited scope for fiscal and monetary policy to influence the real economy.

In an October 2009 paper co-authored by the laureates and two others, they appeared to acknowledge some shortcomings: “Lack of confidence in [macroeconomic] models seems to have become pronounced in the recent financial crisis and has entered policy discussions”.

Sims, who was born in Washington, D.C., told a telephone news conference in Stockholm, where the award was announced, that the methods he and Sargent used and developed "are central for finding our way out of this [economic] mess."

Sims was reluctant to offer specific prescriptions, but at a news conference at Princeton later Monday, he said he agreed with Fed Chairman Ben S. Bernanke that the central bank's monetary policy by itself wasn't enough.

Echoing Bernanke, Sims said Congress and the White House needed to develop fiscal policy that included a credible budget plan to reduce the deficit without doing short-term damage to the still-fragile economy. 

Related: Nobel Prize Winners in Economics