Sargent and Sims and Macroeconomics after Keynesianism

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By Amar Yumnam
Now the world is concerned with the issues of financial meltdown. These issues affect the economy of a nation as a whole and so they are macroeconomic issues. This year’s Nobel Prize in Economics has been awarded to Christopher Sims of Princeton University and Thomas Sargent of New York University. Both were good friends as graduate students (what we call here Masters and doctoral scholars) at Harvard University during the 1960s and have remained so since then. They started their career together at the University of Minnesota before they shifted to different universities. It is a wonderful coincidence that both are teaching a graduate Macroeconomics course at Princeton University in the current semester.

While they were students at Harvard University in the 1960s, the Keynesian thinking of effectiveness of government policies to control economy-wide problems of inflation and unemployment were enjoying their heyday in both teaching and policy. But during the 1970s and 1980s these were subjected into increasing scrutiny and rebuttal. These attacks were mainly from two groups. One group was the one known as Monetarist led by the inimitable Milton Friedman of Chicago University and the other were the Rational Expectations group of which Sargent and Sims are protagonists. Most of the leading figures of both the groups (Friedman, Lucas, and Prescott to name a few) have already won the Nobel Prize.  In fact, we can say that with this year’s award, the ceremony is more or less complete for most of the important contributors to the post-Keynesian Macroeconomics.

Of the two, Sargent is one of the original Rational Expectations contributors. This group of economists were pointing out one basic weakness of Keynesian Economics not founding on the behaviour of single individuals. They emphasise that the behaviour of individuals as individuals are significant in explaining the economy-wide macro phenomenon. They emphasise that every individual takes into account all available information including government policies while taking a decision. This being the case, government interventionist policies would not be effective in the long run to address the macroeconomic problems of prices and employment. Thus only random and short run monetary policies would be effective in achieving short run real objectives because they were not anticipated by the rational individuals.

Sims on the other hand is known for his contributions to statistical analyses without much involvement of Economics. His analyses apply mainly to the examination of ups and down in the business of an economy. He also reached at more or less the same conclusions as the Rational Expectations group, and so commonly identified with this group.

There are two commonalities between these two economists. Both talk of the ineffectiveness of monetary policies to stabilise an economy, and the necessity of taxation and public expenditure policies to address the latter. Even more important, both believe, like Friedman and others, that a capitalist economy is inherently stable. When the West is going through such a crisis as they are right now, no other morale booster is more significant than this belief.

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