Breaking down the Nobel Prize for Economics 2026

Akshara (0:04)

In today's episode, we'll do one deep dive and cover another story for the day. First, we'll break down the Nobel Prize for Economics 2026, and then we'll talk about IDBI's long road to privatization.

Welcome back to The Daily Brief by Zeruda, where we cut through the noise to help you understand what's actually happening in the most important stories from business and markets. I'm your host Akshara. Today is Friday, 16th October.

Coming to the first story.

Now, you may already know that the Nobel Prize for Economics is not a real Nobel Prize. It's really awarded by the Swedish Central Bank. And this year, they've awarded the prize to economists Robert Hall and Michael Woodford. Their work provided much of the intellectual foundation to the policies pursued by most central banks in the world, from the RBI to the US Federal Reserve. Well, maybe the Federal Reserve is having second thoughts about that now.

See, Kevin Walsh, who is the new chairman of the US Federal Reserve has spent his first months in office dismantling one of Michael Woodford's signature ideas, forward guidance, which refers to the practice of telling markets what the central bank plans to do with interest rates in the future. So Walsh explicitly said that unlike most of his peers, he doesn't believe in it. Now, this tension is what makes this prize and the criticisms it's already under worth understanding.

Now, to understand why the Nobel Prize Committee picked these two, we need to start with a problem that nearly destroyed mainstream economics in the 1970s. So in the 1970s, Western economies got hit by a one-two punch of high inflation and high unemployment simultaneously, primarily due to the oil crisis of the 1970s. Another time, one of the long-standing beliefs in the economic profession was that there was a trade-off between inflation and unemployment. And to curb one, you sacrifice the other. But the new crisis broke that relationship entirely. Robert Lucas, who is an economist who would later win his own Nobel Prize, famously critiqued that economic models of the time treated relationships between economic variables as fixed rules only because past information said so. But people aren't particles. So when the government changes its policies, people change their behavior in response. And a relationship that held true earlier could fully fall apart. Another such relationship was that if your income goes up by 100 rupees, you'll spend some predictable large fraction of it, like 80 rupees and save the rest. This consumption function was the engine of the policy toolkit of the time. And if the government wanted to stimulate the economy, it could put money in people's hands like a stimulus or a tax cut, and they would spend a predictable share of it, creating a multiplier effect that rippled through the economy.

But there's just one hitch with this tale. What if households aren't just people relying on historical data but also forward-looking? Suppose you find out today that you're getting a big raise in April 2027 If you can borrow against that future income, you start spending more now without waiting for the future paycheck. And when you stretch it over a longer horizon, you come to the idea that people spend not on the basis of what they earn today, but what they expect to earn over their whole lifetime. You would also make such a prediction based on what you earned in the past. Now, if true, it would mean that the old idea of giving people money today and they have spent a predictable chunk of it, didn't stand up to scrutiny, even if it sounded legitimate in theory. So if, say, a government cuts interest rates, the spending boost would get spread out over a lifetime of spending, rather than being immediate. That's where Robert Hall enters the story. So in a landmark 1978 paper, Hall said that if consumers are rational and forward-looking and can borrow and save freely, what they spend today contains all the information you need about what their future consumption looks like. Past information about their paychecks is not necessary, and if there's a difference between tomorrow's and today's consumption, it would only be because of an unforeseen event. So Hall and his colleague Frederick Mishkin tested this theory on actual household data in 1982, and they found that it described about 80% of households well. But the remaining 20%, which were predominantly lower-income families without access to savings or credit, spent what they got when they got it. So the old model wasn't entirely wrong. But Hall and Mishkin's results seem to have severely undermined it. Eventually, there were critiques of these results, and we'll come to that. But in the short run, Hall's 1978 result gave macroeconomics what it desperately needed after the stagflation crisis. Hall had many contributions to economics, but this was the most influential one. So the question that arises now is, keeping Hall's hypothesis in mind, how should a central bank navigate rate hikes or cuts? Or how should a government decide when to announce a tax cut or raise to influence household expenditure? A couple of decades later, Hall's co-winner Michael Woodford, who actually never wrote a paper with Hall, would provide a model for that. So in 2003, Michael Woodford published a book called Interest and Prices. It revived an old economic idea which said that there exists a natural rate of interest or R at which the economy is neither overheating nor cooling down. And if the central bank can find this rate and park its policy rate there, prices stay stable and the economy hums along. So what Woodford built was a three-part model that gave central banks a complete operating manual. The first part was Hall's 1978 contribution. Woodford turned Hall's spending rule into the demand side of his model. After all, changes in the interest rate affect consumption significantly.