Both Christopher Sims and Thomas Sargent investigated the thorny problems of identifying cause and effect when dealing with macroeconomic time series variables that are highly correlated with each other. This joint award can be thought of as the second in its line of research, the joint award to Clive Granger and Robert Engle being the first, and the latest in a series of awards for contribution to statistical analysis.
But, neither Sims’ nor Sargent’s contributions were predominantly in statistical analysis. Sargent and Sims developed aspects of the rational expectations revolution in economics. This challenged the dominant Keynesian economics insofar as Keynesians, to simplify their argument, think markets can be repeatedly fooled by policy makers. For examples, that workers can be fooled by inflation into accepting employment at lower wages and therefore that inflation can be used to lower the unemployment rate. In this regard, Sims and Sargent built on the work of Milton Friedman and Edmund Phelps and others.
In addition, both Sims and Sargent contributed to the fiscal basis of monetary policy and of inflation (in which line of investigation, Sargent is often associated with Neil Wallace, who might be said to be this year’s unnamed co-contributor). Basically, while Keynesians suppose that monetary and fiscal policy are two distinct policies, enabling the government to simultaneously pursue two goals, namely, price stability and low unemployment), Sims and Sargent investigated the conditions under which fiscal policy is all that matters. These conditions involve continuing high deficits, which make some form of default inevitable.
The sudden interest in their line of inquiry into continuing high deficits, and the relevance of the contributions of Sims and Sargent of some forty years ago, is precisely due to the continuing high deficits of the U.S., and the austerity budgets adopted first in the U.K. and now in Portugal and being urged upon certain countries on the periphery of the Eurozone by Germany among others.
The dominance of fiscal over monetary policy might seem to restore old-fashioned Keynesian policy, but; no, not exactly. Keynesianism, an increasing number of economists are saying, presupposes a solvent government and a currency whose purchasing power is well-anchored, which gives the government certain but limited policy options to deal with problems such as recession. The contrasting viewpoint, best associated with Paul Krugman, is that the Keynesian model is essentially linear, so that no deficit, no matter high big, is ever to worry about and if an apparently large deficit doesn’t actually succeed in stimulating an economy, it is because it is not large enough.
Thank you