Nobel economics prize inspires optimism

  • By James McCusker
  • Wednesday, October 14, 2015 3:38pm
  • Business

The decision to award this year’s Nobel Memorial Prize in Economics to Angus Deaton is a refreshing reminder of why studying economics is so rewarding…and so hard.

According to the selection committee, Deaton, a Princeton University professor, received the award for his work on three fundamental questions that directly affect economic policy decisions:

“How do consumers distribute their spending among different goods?

How much of society’s income is spent and how much is saved?

How do we best measure and analyze welfare and poverty?”

Like so much of the best economic research, though, Deaton’s work began as a mystery story about economic policy that had lots of data and an unanswered question: why didn’t it all add up?

The mystery surrounded the frequent failures of economic policies aimed at things like boosting economic development, improving living conditions, or simply increasing consumption. There are, of course, political answers to these questions — we are awash in them in the everlasting campaigns of modern politics — but solid economic answers are more difficult to come by.

There was no shortage of data. The federal government has plenty of it. What bothered Prof. Deaton, however, was that the data didn’t seem to add up to consistently effective policies when fitted into the aggregate macroeconomic models used by the Federal Reserve, Congress, and other economic policy makers.. This, he believed, might explain why economic policies were so unreliable — why they worked one time and then failed the next. He thought that the answer lay in the data on how individuals and households actually behaved. The better we understood that and quantified it, the better the economic theory and policy would be.

In a sense it was “doing it the hard way.” Instead of using the cleaned up aggregates, it meant working with the raw data, with all its errors, contradictions, and imperfections. In a very real way the process resembled old-fashioned detective work, which still entails endless telephone calls, witness interviews and re-interviews, staring at computer screens, and even pounding pavements. In the end, Deaton’s work provided the insight needed to solve the mystery and get closer to his goal of helping people escape from poverty.

It was not a surprise that the prize went to Professor Deaton. He had been short-listed for the award for several years. What was surprising, though, is that he was not cited for his work in building a bridge between the two separate kingdoms of economic theory: microeconomics and macroeconomics.

Microeconomics concerns itself with how resources are allocated by individuals and by firms. Macroeconomics looks at the aggregates, the allocation of resources in the entire economy.

It would not be wrong to think that macroeconomics would simply be what you got when you added up all the resource allocation decisions of individuals and firms — but it turns out that it isn’t as simple as that, either theoretically or practically. At the heart of Professor Deaton’s work, then, is a bridge that satisfies both the practical and theoretical issues in at least one area: consumer behavior.

Consumer behavior is at the heart of all government efforts to stimulate growth in a declining, stagnant, or lethargic economy, and it is no secret that we have enjoyed all three types over the past few years. In our economic policy system, we employ the Federal Reserve to set the stage by lowering interest rates, which encourages business investment, then tries to make that investment more attractive by putting more money into consumer’s hands and increasing consumption.

There are few people in the United States who are unaware of the disappointing results of our efforts to stimulate economic growth since the Wall St. crash. Instead of growing the overall economy they mostly grew the financial sector and swelled the bank accounts of the already wealthy. While this was unintentional, certainly, we are still living with the consequences, and still trying to figure out a way to stimulate real growth in our economy.

Could economic policy makers have done a better job if they had paid more attention to Professor Deaton’s work? It’s very possible, but only if they were prepared to do the get-your-hands-dirty statistical work that would be necessary… and it is just so much easier to tweak the aggregates in an economic model to correct it so that it now predicts the past perfectly.

By awarding the Nobel Memorial Prize in Economics to Angus Deaton, the committee signaled an appreciation of the value of hard work to establish the fundamentals of economics.

It is easy to feel optimistic about this award and the effect it will have on the theoretical and practical work of economists and on our economy. Optimism and economics in the same sentence. Imagine that!

James McCusker is a Bothell economist, educator and consultant. He also writes a column for the monthly Herald Business Journal.

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