Nobel economics laureate Woodford: "Economic policy should not be run like pulling a lever"

Overcame the limitations of Keynesian economics since the 1970s
Laid the theoretical foundations for central bank interest rate policy and communication with markets

Michael Woodford, a professor at Columbia University in the United States who was named a co-recipient of this year's Nobel Prize in Economic Sciences, said on October 12 (local time) that governments and central banks should communicate actively with markets, rather than unilaterally implementing policies, to stabilize the economy.

He cited "forward guidance," in which central banks signal the future path of interest rates in advance, as a leading example of his research being applied to real-world policy. His remarks are being interpreted as a reminder of the importance of central banks managing market expectations and communicating with markets, at a time when forward guidance has effectively been suspended since Kevin Warsh took office as chair of the U.S. Federal Reserve (Fed).

The Nobel Committee of the Royal Swedish Academy of Sciences announced on the 12th (local time) that it had selected Professor Robert Ernest Hall and Professor Michael Woodford as the recipients of the Nobel Prize in Economic Sciences. AFP-Yonhap News

In a telephone news conference held on October 12 shortly after the Royal Swedish Academy of Sciences announced the Nobel Prize in Economic Sciences laureates, Professor Woodford said, "Governments should not view economic stabilization policy simply as pulling a lever to control the economy."

He said, "Policies should not be implemented without regard to how economic actors understand them," adding, "How people making decisions about spending and other matters in the market anticipate and understand future policies is very important to their actual effects."

"It is also important to develop a theoretical framework that enables the government to explain to the public what policies it is implementing and communicate about them," he added. "That was one of the key goals I had in developing my analytical framework."

Professor Woodford is a leading scholar of New Keynesian economics, which incorporates households' and firms' expectations about the future into macroeconomic models to analyze the effects of central bank interest-rate policies on the economy. In particular, he theoretically demonstrated that central banks can influence prices and economic activity not only by adjusting current interest rates, but also by shaping market expectations about the future path of interest rates.

He cited central banks' responses to the 2008 global financial crisis as a leading example of his research being applied to real-world economic policy.

At the time, central banks in major economies, including the United States and Sweden, lowered benchmark interest rates to virtually zero, but high unemployment and weak demand persisted. With further rate cuts becoming difficult, central banks sought to stimulate the economy by using forward guidance to influence market expectations, signaling the direction of future interest-rate policy in advance.

Professor Woodford said, "This involved explaining more explicitly the path that future interest-rate policy would take, and was a different approach from relying solely on further immediate rate cuts." He added, "I don't think it solved every problem as if by magic, but I believe it made an important contribution to economic stabilization."

The remarks have drawn attention amid Chair Warsh's effective suspension of forward guidance since taking office and his emphasis on the market's price-discovery function. Rather than referring to any specific monetary policy decision, Professor Woodford stressed that shaping market expectations about the future path of policy is a key means of making policy more effective.

He identified the war in the Middle East as a threat to the stability of the global economy.

"Events that do not stem from economic causes often have a very significant impact on the economy," he said. "A clear example right now is the war in the Middle East, which is disrupting global energy markets."

He added, "Major changes in energy prices affect many other sectors of the economy, and this is happening in common across many parts of the world." His remarks reflected concern that energy price shocks stemming from the war in the Middle East could spread across the global economy.

He expressed a positive view of China's advances in artificial intelligence (AI). "China appears to have rapidly taken a leading position in technology, including AI," Professor Woodford said, adding, "China could make a major contribution to global economic development over the coming decades."

On receiving the Nobel Prize in Economic Sciences, he said, "It is a tremendous honor. I did not expect it, but I am truly delighted."

Meanwhile, the Royal Swedish Academy of Sciences named Professor Woodford and Robert Hall, 83, a professor emeritus at Stanford University in the United States, as this year's co-recipients of the Nobel Prize in Economic Sciences. Their award-winning work is titled "Microeconomic Foundations of Macroeconomic Stabilization."

The Academy said the two scholars developed a new macroeconomic model explaining how household and business decisions affect consumption, investment, prices, and economic fluctuations, thereby improving the effectiveness of economic stabilization policies.

In particular, New Keynesian models developed on the basis of their research are now widely used by central banks and governments around the world to formulate monetary and fiscal policies.

This content was produced with the assistance of AI translation services.