Thursday, October 08, 2009

The Nobel Goes To ...

Mankiw lists Eugene Fama and Paul Romer as huge favorites. If they give it to Fama, they should give it to French, even though Fama has a much deeper set of contributions (the definition of the Efficient Markets Theory in 1970), because for the past 20 years most of their papers have been joint, and they have really dominated the debate on issues from models of bonds to equities. I don't know much about Romer's work, but it's at least as influential as Krugman's in the idea that increasing returns to scale are very important in growth, so I presume that means he'll get it if he lives long enough.

As I note in my book, I'm a rather strong critic of Fama's work on equity risk factors. Yet, in terms of impact, Fama is clearly a force. Further, I truly admire his style, in that his articles are very clear, unlike most 'top' financial economists. Many financial economists in the 80's were focused on abstruse issues of econometrics that turned out irrelevant (eg, the simultaneous estimation of betas and the zero-beta return, exact finite sample distributions). After Fama-French 1992, where they introduced the three factor model (the market, value, and size factors) and basically made it safe to say the CAPM did not work (Fama graciously admits this paper merely consolidated what everyone knew studying the value and size 'anomalies' for the prior decade), finance became much more practically focused, more relevant.

But, I'd have to say, this isn't a good year for giving the prize to someone so closely identified with the Efficient Markets Hypothesis. Barro, Sargent, or Sims seem like good choices, as all are part of the cannon, each with essential insights. Sims really put the fork in the Keynesian Macro Model mania of the 1960s and 70s, showing that simple vector autoregressions outperformed these models (Macroeconomics and Reality, 1980). VARs remain a key tool for macroeconomists, and Sims did a lot of work in this area. I imagine few Fed briefings do not involve stimulus-response estimates generated via VARs. It's a very applied approach, because it basically says, don't be too specific in your causal model (like the Keynesian Macro models), yet, it does not suggest one use totally nonparametric, or unidentified models. He basically says, find the main variables that should affect things (like GDP) via theory, then look at how the past values of those predictors explain the predicted variables, and plot them in a graph.

Barro highlighted that if people were rational, borrowing money is the same as raising taxes, because people anticipate future taxes, extinguishing any stimulus via deficit spending (Are Government Bonds Net Wealth? 1974). The phrase, "Ricardian equivalence," has become well known among scholars in macroeconomics and public finance (James Buchanon noted some writing of Ricardo's that had some inklings of this back in the early 1800s). It refers to a situation in which taxation and government borrowing have the same effects on the economy. The equivalence can arise because government borrowing tends to increase future taxes (to pay interest and principal on the public debt) and, as long as the present value is the same, people may react to anticipated future taxes just as they do to current taxes. To put it another way, a reduction in the government's saving due to a current budget deficit may induce the private sector to save correspondingly more. The total of national saving is then invariant to the government's borrowing. No more Keynesian stimulus effect from government borrowing.

Lastly, Sargent is a cofounder of the new classical macroeconomics based on rational expectations and dynamic stochastic models. A lot of work he did was highly technical, but influential economists write for economists, and his books on Macroeconomic Theory and Dynamic Macroeconomic Theory really concisely described the macroeconomic toolkit better than any other books of his generation. In those books, he takes models like Robert Lucas's Island Model, the Modigliani-Miller Theory, or Barro's Ricardian Equivalence, and boils them down to their essentials. His paper Some Unpleasant Monetarist Arithmetic (1981) nicely shows via some simple algebra that if fiscal policy is independent of monetary policy it can generate inflation by basically forcing future seignorage to pay off debt. This is very relevant to countries in excessive deficit spending mode.

Interestingly, as technical as these guys are, their most influential work is much more accessible than work that came later. Many who saw their success incorrectly inferred that it was their technical expertise that made them successful, and so instead of extending their economic ideas, tried to simply create more complicated mathematics (eg, Kalman filters instead of VARs, Judd's growth models). Similarly, I remember in grad school my professors then thought of Fama as insufficiently rigorous compared to say Gibbons, Ross, or Shanken. I doubt they remember that now. I think Macro is a mess, but these guys kept it from being a whole lot less messier. I guess that's seeing the glass half full.

Update: it appears Barack Obama's chances of winning the Nobel for his stimulus plan is not insignificant.

8 comments:

Anonymous said...

For years there has been a snobbish criticism that the econ Nobel is not a real Nobel prize. Given the current climate of “rage” in political and economic discourse ( an example being the rantings of Brad DeLong about the musings of John Cochrane) giving the econ Nobel to Fama would expose the folks awarding the prize to a lot of “progressive” criticism. Giving the Nobel to Fama would give DeLong, Krugman and their ilk a new target to froth over. The SNL Obama skit provided evidence that the Obama administration’s honeymoon is over. Giving the Nobel to Fama would provide some critics of the econ Nobel with the ultimate WTF moment.

Noah said...

Giving the Nobel to Fama a year after the biggest market crash in modern history would be only slightly more absurdist than giving it to Barro the year that massive stimulus has been widely credited with saving the economies of the U.S. and China from deep depressions.

I predict it goes either to Mortensen & Pissarides or to Paul Romer.

ZH said...

It will go to Lars Peter Hansen for GMM (not for his macro or labor work). Everything macro and finance are too controversial this year, trade got it last year, and micro theory got it two years ago so neither of those fields will have the winner either. Bhagwati deserved to share it with Krugman last year, and they could give to him this year for his work on development or rent seeking, but he is primarily thought of as a trade economist, and if he wins it at all it will be for trade which means he will have to wait a few years.

Anonymous said...

I too think Lars Hansen shd get it for GMM.

Anonymous said...

I have a number of thoughts when I look at the list of econ Nobel prize winners. The most powerful impression is that it is a rogues gallery of proponents of tired and uselss ideas. Which makes me think "who cares who wins this year or any year?" When I think of the hype surrounding the econ Nobel I am reminded of Steve Martin jumping for joy in the movie "The Jerk" (when he finds out that he is listed in the phone book)....

Anonymous said...

Back in the mid-90s when I studied the academic lit, Romer had the most influence on how I think about economic issues. My anonymous blog vote goes to Romer.

J said...

Given that Nobel Prizes are also given for creating a new environment and bringing hope, without any need for achievement (see President Obama), I think we are in for a surprise Nobel in Economy. Bernie Madoff brough much hope to thousands for many years, he may be shortlisted.

zarkov01 said...

"For years there has been a snobbish criticism that the econ Nobel is not a real Nobel prize."

It's not a "real" Nobel. the Sveriges Riksbank bribed the Royal Swedish Academy to administer their prize for them. It has nothing to do with the prizes Nobel set up. Economists suffer from physics envy and have tried to make a branch of sociology look like a hard science, specifically thermodynamics. Samuelson admits being influenced by Gibbs.

Can you get a "real" Nobel in the hard sciences for a false theory like the CAPM? Not yet anyway.