The Nobel for the Idea That Expectations Run the Economy

[THE PRIZE] A model with a lineage.

• Every time the Federal Reserve meets, it runs the economy through a model before it touches interest rates.
• That model has a lineage, and this autumn the Royal Swedish Academy of Sciences traced it back to two American economists.
• Robert Hall of Stanford and Michael Woodford of Columbia share the Sveriges Riksbank Prize in Economic Sciences, the prize most people call the Nobel in economics, "for microeconomic foundations of macroeconomic stabilisation."
• Strip the jargon and the citation says this.
• They worked out how to build a picture of the whole economy from the decisions of the people in it, and central banks have been steering by that picture ever since.

[THE BREAK] The old recipe failed.

• The problem they inherited was a model that stopped working.
• The postwar recipe for managing an economy, cut rates and spend in a slump, do the reverse in a boom, rested on statistical patterns between big numbers, such as the link between unemployment and inflation.
• In the 1970s those patterns broke.
• Oil shocks pushed inflation and unemployment up together, which the old charts said could not happen.
• Timo Boppart, a member of the prize committee, put it plainly to the Associated Press: "This is the Keynesian recipe and it worked well, until it didn't."

[THE CRITIQUE] People look ahead.

• The critique, led by the Chicago economist Robert Lucas, himself a Nobel laureate in 1995, was that economies are made of people who look ahead, and a model that ignored that would keep being surprised.

[HALL] Spending you can't predict.

• Hall's answer, in a 1978 paper, was elegant and testable.
• If households spend according to what they expect to earn over their lives, then spending already contains everything they know.
• It should change only when something genuinely new happens, and genuinely new information is, by definition, impossible to predict.
• So changes in consumption should be unpredictable too.
• He checked, and no variable reliably forecast them.
• Four years later, with the economist Frederic Mishkin, he looked at household data and found about 80 percent of families behaved that way, while the rest lived hand to mouth, spending whatever came in.
• That split, the planners and the paycheck-to-paycheck households, is written into the models central banks use today.

[WOODFORD] A laboratory for policymakers.

• Woodford built the machine that uses it.
• His 2003 book, Interest and Prices, laid out a compact model of the economy with three working parts, which the Academy describes as "a kind of laboratory for policymakers."
• First, people spend more or less depending on how today's interest rate compares with a "natural" rate, the one the economy would settle at on its own.
• The idea comes from the Swedish economist Knut Wicksell, who proposed it in 1898, and it is why central banks now steer the economy by setting interest rates rather than by controlling how much money is in circulation.
• Second, prices are sticky because changing them costs something, so when a firm does reset a price, it looks ahead.
• If it expects its rivals' prices and its own costs to rise, it sets a higher price now.
• Inflation, in other words, runs on expectations of inflation.
• Third, the gap between what the economy is producing and what it could produce measures the pressure, and policy's job is to close it.

[THE PROMISE] Words as a tool.

• The second part is the one that changed how central bankers talk.
• If expectations drive prices, then a central bank's words are a tool, and a credible promise can do some of the work a rate change would.
• Woodford made the case formally in a 2003 paper with the economist Gauti Eggertsson on what to do when rates are already at zero, and again at the Fed's Jackson Hole conference in 2012, where he argued for guidance tied to a stated goal rather than a calendar.
• Asked by the Nobel Foundation what his work comes down to, he said the job of public authorities "should be to talk to people, and to talk to them about what's being done, including justifications for what's being done."
• He also gave a concrete example to NPR.
• A business that sees a cost increase as temporary usually eats it; one that sees it as lasting passes it on fast.
• "It isn't just the current costs that are going to matter for that decision," he said.

[THE TARGET] Two percent, announced.

• The Fed took the advice.
• In January 2012 it announced a 2 percent inflation target for the first time, saying that communicating the goal clearly "helps keep longer-term inflation expectations firmly anchored," and it has reaffirmed the statement every January since, most recently this year.
• The number itself has a strange history, which Noozify covered in August.
• Woodford's contribution is the reason announcing it mattered.

[OUR CHECK] Markets believed it. Households didn't.

• So did it work?
• We pulled the record.
• The gauge the Fed watches most closely is what bond prices imply about inflation five to ten years out.
• On the day of the 2012 announcement it stood at 2.43 percent.
• Through the inflation of 2021 to 2023, when consumer prices were rising more than 8 percent a year, it never averaged above 2.31 percent in any year, peaked at 2.67 in April 2022, and sits at about 2.2 percent now.
• Markets, in other words, believed the promise.
• Households did not.
• The University of Michigan asks consumers what they expect over the next year, and that number went from 2.3 percent at the end of 2019 to 5.4 in the spring of 2022, fell back, then hit 6.6 percent in May 2025 during the tariff scare, the highest since 2021, and was 4.6 in September.
• The chart on screen is the whole argument in two lines.
• Expectations are anchored where the professionals are (bond investors and the forecasters who advise them) and loose where the shoppers are (households answering a survey about next year's prices), which is a result Woodford's own model would predict, since it is the price-setters, not the public, whose expectations go straight into prices.

[THE DEBATE] Not without argument.

• The prize is not without debate, mostly inside the profession.
• Brian Albrecht, an economist who writes the newsletter Economic Forces, called it "a great macro prize" while noting that the model has no money in it, that Hall's own later work found consumption barely responds to interest rates, and that pairing the two men "takes a little more squinting."
• The committee's own write-up concedes that "recessions and episodes of high inflation have not disappeared."
• And the people who are not on the list say something too.
• Julio Rotemberg, the economist who was Woodford's co-author on the papers that built the framework, died in 2017, and the prize is never given posthumously.

[THE WINNERS] Hall, 83, and Woodford, 70.

• Hall is 83 and has chaired the committee that officially dates American recessions for more than three decades.
• Woodford is 70, came to economics by way of Yale Law School, and was woken at 4:30 in the morning by the call from Stockholm.
• He still gave his scheduled exam a few hours later.
• They will share 12 million kronor, about $1.2 million, in December.
• The committee's closing line in its public summary is the best measure of what they did.
• The next time your central bank sets a rate, it said, you can be sure one input into the decision was a calculation run on the kind of model these two built.