Nobel Economics Prize 2026: New Keynesian Macroeconomics

NOBEL ECONOMICS PRIZE 2026: NEW KEYNESIAN MACROECONOMICS

When growth is low, the government can boost it by increasing its spending. But how much must the government exactly spend? When inflation is high, the central bank can reduce it by increasing the interest rate. But how much must the interest rate actually be? This year's Nobel Economics Prize goes to two economists who answered these very important questions.

The traditional Keynesian macroeconomic models were based on the *historical relationships* among the macroeconomic variables. They worked well till the 1970s, when two oil shocks (1973 and 1979) caused a breakdown in these historical relationships - and led to stagflation (low growth and high inflation - ie, the worst of both worlds) in that decade.

In 1978, Robert Hall wrote a paper titled 'Stochastic Implications of the Life Cycle - Permanent Income Hypothesis: Theory and Evidence' in Journal of Political Economy (6k citations). In it, he proved that households' consumption depends on their expectations of their future income.

In 2003, Michael Woodford wrote a book titled 'Interest and Prices: Foundations of a Theory of Monetary Policy' (14k citations). He used Robert Hall's finding and built a New Keynesian macroeconomic model on a solid foundation of *microeconomic theory*.

The model consists of 3 equations (see top pic):

1. New Keynesian IS curve

Output gap in period t = Expectation in period t of the output gap in period t+1 minus a constant multiplied by the expected real interest rate gap (ie, nominal interest rate in period t minus the expectation in period t of the inflation in period t+1 minus the natural real interest rate in period t)

2. New Keynesian Phillips curve

Inflation in period t = Discounted expectation in period t of the inflation in period t+1 plus a constant (Phillips curve slope) multiplied by the output gap in period t

3. Taylor's monetary policy rule

Nominal interest rate in period t = Steady-state real interest rate plus inflation coefficient multiplied by inflation in period t plus output coefficient multiplied by output gap in period t plus a shock

Using this model, governments decide how much to spend and central banks decide the interest rate - in order to boost growth when it is low and reduce inflation when it is high.

This decade has seen a series of global economic crises: Covid pandemic, Ukraine War and Iran War. Yet the world economy is much better today than it was in the 1970s. The credit for this goes to the New Keynesian Model - which has become the most fundamental macroeconomic policy-making model in the world today. And the architects of this model are Robert Hall and Michael Woodford. So this is a very richly deserved Nobel Prize . . . !

Info-source: Nobel Prize Org

Bottom pic: Robert Hall and Michael Woodford