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Prize in Economics addresses a more fundamental question: ",[113,114,115],"strong",{},"how can we understand and manage an economic system made up of billions of individual choices?",[106,117,118],{},"This work connects individual behavior, economic fluctuations and the policy frameworks of modern central banks.",[106,120,121],{},"The award recognizes two central figures: Robert E. Hall, for his research on consumption and expectations, and Michael Woodford, for his contributions to modern monetary policy theory.",[106,123,124],{},"Their work helped advance modern macroeconomics. An economy is more than a handful of changing indicators: it is a complex system formed by interacting individual decisions.",[126,127,129],"h2",{"id":128},"why-do-economies-fluctuate","Why do economies fluctuate?",[106,131,132],{},"If markets always worked efficiently, an economy should be able to return to equilibrium automatically.",[106,134,135],{},"When profits fall, firms cut costs. When wages fall, firms hire more workers. As prices adjust, supply and demand come back into balance.",[106,137,138],{},"This is an important idea in traditional classical economics.",[106,140,141],{},"Reality, however, does not always follow that pattern.",[106,143,144],{},"The 2008 financial crisis and the global inflation following the pandemic show that economies can remain out of balance for extended periods.",[106,146,147],{},"One reason is that the real world contains many “frictions”:",[149,150,151,155,158,161],"ul",{},[152,153,154],"li",{},"Wages do not adjust immediately.",[152,156,157],{},"Firms do not change prices instantly.",[152,159,160],{},"People do not have complete knowledge of the future.",[152,162,163],{},"Investment decisions depend on confidence.",[106,165,166],{},"These factors make the economy a more complicated dynamic system.",[126,168,170],{"id":169},"from-current-income-to-future-expectations","From current income to future expectations",[106,172,173],{},"One of Robert Hall’s important contributions concerns consumption behavior.",[106,175,176],{},"Many simple models used to assume:",[178,179,180],"blockquote",{},[106,181,182],{},"When income rises, people consume more.",[106,184,185],{},"Actual behavior is more complicated.",[106,187,188],{},"A young engineer may earn relatively little today. If they expect their income to rise significantly, they may still be willing to invest in education, buy a home or make long-term spending commitments.",[106,190,191],{},"Conversely, someone with a high income may cut spending if they fear that economic conditions will deteriorate.",[106,193,194],{},"Consumption therefore depends not just on the present, but also on people’s judgments about the future.",[106,196,197],{},"This leads to an important idea:",[178,199,200],{},[106,201,202],{},"Economic activity depends to a considerable extent on expectations about the future.",[106,204,205],{},"That is also why the signals conveyed by government policy announcements matter so much.",[126,207,209],{"id":208},"why-do-central-banks-care-about-expectations","Why do central banks care about expectations?",[106,211,212],{},"Michael Woodford’s research further developed modern monetary policy theory.",[106,214,215],{},"People often explain central bank interest-rate decisions through a simple chain:",[106,217,218],{},"Higher interest rates → more expensive borrowing → less consumption and investment → lower inflation.",[106,220,221],{},"Modern economics emphasizes that the current interest rate is only part of the story. How people interpret the central bank’s future actions matters too.",[106,223,224],{},"For example, if a central bank clearly signals that it will maintain a restrictive policy for some time, firms may reduce investment and households may borrow less before those future decisions actually arrive.",[106,226,227],{},"In other words:",[178,229,230],{},[106,231,232],{},"A central bank influences both today’s interest rate and society’s expectations about the future.",[126,234,236],{"id":235},"the-operating-system-of-modern-economics-dsge-models","The “operating system” of modern economics: DSGE models",[106,238,239],{},"These lines of research helped develop dynamic stochastic general equilibrium models, or DSGE models.",[106,241,242],{},"The name sounds complicated, but one way to think of such a model is as an economic simulator.",[106,244,245],{},"It attempts to build a virtual economy describing:",[149,247,248,251,254,257],{},[152,249,250],{},"How people consume.",[152,252,253],{},"How firms set prices.",[152,255,256],{},"How banks lend.",[152,258,259],{},"How governments make policy.",[106,261,262],{},"Researchers then introduce shocks such as:",[149,264,265,268,271,274],{},[152,266,267],{},"Rising energy prices.",[152,269,270],{},"Financial crises.",[152,272,273],{},"Technological change.",[152,275,276],{},"A global pandemic.",[106,278,279],{},"They observe how the system responds.",[106,281,282],{},"This resembles a control-system problem in engineering: introduce a disturbance, analyze the response and look for ways to make the system more stable.",[126,284,286],{"id":285},"why-does-this-matter-to-ordinary-people","Why does this matter to ordinary people?",[106,288,289],{},"Many questions behind modern economic policy depend on these theories.",[106,291,292],{},"Why do central banks raise interest rates when inflation is high?",[106,294,295],{},"Why might lower interest rates stimulate economic activity?",[106,297,298],{},"Why does a one-time government payment not necessarily produce an equally large increase in consumption?",[106,300,301],{},"The answers all involve how people make decisions in light of the future.",[126,303,305],{"id":304},"economics-is-not-a-perfect-prediction-machine","Economics is not a perfect prediction machine",[106,307,308],{},"These models have also faced criticism.",[106,310,311],{},"After the 2008 financial crisis, many economists argued that traditional macroeconomic models did not adequately describe sudden collapses in the financial system.",[106,313,314],{},"Real people are not always rational calculators.",[106,316,317],{},"Panic, emotions, institutions and inequality all affect how an economy works.",[106,319,320],{},"Modern economics therefore continues to incorporate additional considerations:",[149,322,323,326,329,332],{},[152,324,325],{},"Behavioral economics.",[152,327,328],{},"Financial frictions.",[152,330,331],{},"Differences between income groups.",[152,333,334],{},"Complex network models.",[126,336,338],{"id":337},"seeing-economics-as-a-complex-system","Seeing economics as a complex system",[106,340,341],{},"If physics studies natural laws and computer science studies information systems, modern economics studies a complex system made up of people.",[106,343,344],{},"Each person is a decision-making node: consuming, investing, working and saving.",[106,346,347],{},"Markets connect these local actions, which together produce changes in the global economy.",[106,349,350],{},"The significance of the 2026 economics prize goes beyond explaining how to predict GDP.",[106,352,353],{},"It points toward a broader idea:",[178,355,356],{},[106,357,358],{},"To understand a complex system, we need to understand its participants’ behavior and their judgments about the future.",[106,360,361],{},"This is also where modern economics increasingly overlaps with research on artificial intelligence and multi-agent 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