An Economics Nobel awarded for Examining Reality

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This year’s economics Nobel Prize has gone to Oliver Hart and Bengt Holmström, for their work on the theory of contracts. It’s about incentives, and imperfect information, and long-term relationships. But it’s related to lots of real-world economic issues — performance pay, mergers and acquisitions, and bank lending.

What it’s not about is the kind of economics you read about in the news. It’s not about growth or unemployment, fiscal stimulus or interest rates, trade agreements or productivity. It might be indirectly related to those things — Holmström’s work on financial crises and debt certainly has relevance for what happened in 2008. But it isn’t what you expect to see economists arguing about when you open up Bloomberg or pick up the New York Times.

It’s not macroeconomics — the study of how the broad economy works.

Macro Research

That’s interesting, because in the past, the Nobel went almost exclusively to macro research. In the decade after the prize was created by the Bank of Sweden in 1969, nine out of 10 prizes went to things that we would call “macro.” In the 1980s, it was about half.

Nowadays, prizes for macro research are less dominant. The last true macro prize was in 2011, for the empirical work of Christopher Sims and Thomas Sargent. Other macro prizes came in 2010, 2006, and 2004. The prizes in 2013 for financial economics and 2008 for the economics of trade and geography have some macro flavor — after all, trade and finance both affect business cycles and growth — but both are now considered distinct fields, with their own distinct methods and data sources.

Meanwhile, the number of prizes in fields like game theory is on the rise. This year’s winners do work that’s somewhat similar to that of 2014 winner, Jean Tirole, who studied corporations. Micro theorists also won prizes in 2012, 2007 and 2005. Though this is a small sample to work with, it does seem as if micro theory’s star is on the rise within the profession.

Economics debates in the news media and on the blogs tend to make a big distinction between macro and micro, painting the former as unscientific and the latter as serious science. There’s a grain of truth to that, but it’s not that simple.

What really happened was that macro developed first. Economists saw big, important phenomena like growth, recessions and poverty happening around them, and they wrote down simple theories to explain what they saw. The theories started out literary, and became more mathematical and formal as time went on. But they had a few big things in common. They assumed the people and the companies in the economy were each very tiny and insignificant, like particles in a chemical solution. And they typically assumed that everyone follows very simple rules — companies maximize profits, consumers maximize the utility they get from consuming things. Pour all of these tiny simple companies and people into a test tube called “the market,” shake them up, and poof — an economy pops out.

Even today’s macro theories are similar in spirit. Most of what you see in academic seminars or at central banks are so-called general-equilibrium models.

Post from Bloomberg

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