[Insight & Opinion] Managing Expectations Means Managing the Business Cycle

Lessons from the 2026 Nobel Prize in Economic Sciences
Choices shaped by the future, not numbers
Consistent policy that respects rational expectations

This year's Nobel Prize in Economic Sciences has been awarded to two American professors, Robert Ernest Hall of Stanford University and Michael Woodford of Columbia University. The Royal Swedish Academy of Sciences, which selected them as laureates, cited their work on the "microeconomic foundations of macroeconomic stabilization." The award recognizes their contribution to macroeconomics, which had focused on aggregate indicators such as inflation and growth: they put forward-looking households and firms at the center of the analysis and showed how monetary and fiscal policies can reduce economic fluctuations.

After losing credibility amid the stagflation of the 1970s, stabilization policy regained a scientific footing thanks to their work. It would be no exaggeration to say that the foundations of the policy models used today by central banks and finance ministries around the world were laid by these two scholars. Hall is also a longtime leader of the National Bureau of Economic Research (NBER) Business Cycle Dating Committee, which officially determines the peaks and troughs of the U.S. economy. Their achievements offer four lessons for today's economy.

First, policy works through expectations. In 1978, Hall showed that consumption follows a "random walk" if consumers rationally forecast the future. In other words, people base their spending on their expected lifetime income, not just this month's paycheck. This insight explains why one-off cash payments or temporary tax cuts may fail to boost consumption as much as expected. The same logic helps explain why South Korean consumption, weighed down by high interest rates and household debt, has briefly perked up in response to short-term stimulus measures only to fade again. To revive domestic demand, policymakers must change expectations about the future - including the outlook for jobs and income - rather than simply distribute money. As Hall's research on unemployment and job search showed, the quality and stability of employment are the surest sources of that confidence.

This year's Nobel Prize in Economic Sciences laureates. The Royal Swedish Academy of Sciences. Yonhap News Agency

Second, a central bank's words are policy. In his 2003 book Interest and Prices, Woodford established the standard for modern New Keynesian models. His central message is that monetary policy's effects stem not so much from today's policy rate as from market expectations about the future path of interest rates. After the global financial crisis, central banks around the world turned to "forward guidance" to find a way forward when rates were stuck at zero, drawing on his theory. Now, as markets and policymakers haggle over the pace and scale of rate cuts, building trust through consistent and predictable communication is as important as setting rates. Mixed signals increase market volatility and erode the effectiveness of policy. The Bank of Korea also uses conditional forward guidance, disclosing monetary policy board members' projections for future interest rates. Its success depends on how consistently the central bank honors its commitments to the market.

Third, central bank independence and credibility do not come for free. If expectations are the channel through which policy works, credibility is what protects that channel. When politicians pressure a central bank to cut rates to stimulate the economy in the short term, the move may appear effective at first, but markets begin to doubt its commitment to price stability. Once inflation expectations start to rise, bringing inflation under control becomes far more costly. That was the bitter lesson of the 1970s. At a time when calls to undermine central bank independence are growing in major economies, this year's award has reaffirmed, in the language of academia, why independent and principled monetary policy matters. South Korea is no exception. With real estate, household debt and exchange rates intertwined, using monetary policy solely as a tool to stimulate the economy could undermine both confidence in the won and financial stability.

Fourth, monetary and fiscal policy cannot operate independently of each other. Woodford also contributed to the "fiscal theory of the price level," which analyzes how fiscal policy affects prices. If markets do not believe the government can manage its debt, prices will not be brought under control no matter how much the central bank tightens policy. This is a lesson worth heeding now, as fiscal deficits become entrenched in major economies, including the United States, and South Korea faces mounting pressure to spend amid slow growth and an aging population. If confidence in fiscal sustainability collapses, confidence in monetary policy will also be shaken. When fiscal expansion and monetary tightening pull in opposite directions, markets are left uncertain about which signal to trust, and the costs come back in the form of higher government bond yields and exchange-rate instability. Fiscal rules and medium- to long-term fiscal plans are not merely accounting disciplines; they are price-stability safeguards in their own right.

The lesson left by Hall and Woodford ultimately comes down to one point: economies are driven not by numbers but by the choices of people looking to the future, and good policy respects and consistently manages those expectations. The "rational expectations" economists depict in their models appear in the real world as public confidence in governments and central banks. In an era when uncertainty has become the norm, driven by tariff shocks, geopolitical risks and industry restructuring fueled by artificial intelligence (AI), trust is the most important asset governments and central banks must protect. That is the message this year's Nobel Prize offers us.

Cho Won-kyung, Professor of Economics at Sejong University

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