Reshaping Keynesian Thought Wins Nobel Recognition! American Economists Hall and Woodford Reveal the Underlying Logic of Consumption Decisions and Central Bank Policy

The Royal Swedish Academy of Sciences announced on October 12 that the 2026 Nobel Prize in Economic Sciences would be awarded to American economists Robert Hall and Michael Woodford for their outstanding contributions to laying the microeconomic foundations of macroeconomic stabilization policy. These two scholars, both based in the United States, reinterpreted and developed John Maynard Keynes's economic thought after the oil crises of the 1970s. Hall was recognized for a 1978 paper examining why consumers tend to keep their consumption levels stable. Woodford subsequently further developed the so-called "New Keynesian model." To this day, this model continues to exert a profound influence among policymakers worldwide. The far-reaching change brought about by Hall and Woodford's research lies in establishing an analytical approach to macroeconomic policy grounded in microeconomic behavior: by understanding how households consume, how firms set prices, and how people form expectations about the future, one can judge how interest rates and fiscal policy will affect the entire economy. Today, when central banks discuss the natural rate of interest, the output gap, inflation expectations, and the future path of interest rates, the theoretical foundations behind these discussions were advanced by the two laureates. John Hassler, chair of the Nobel Committee for Economic Sciences, said in a statement: "The research of the two laureates has provided a stable theoretical foundation for the models currently used by central banks and governments around the world. With these theories, we are better able to respond to economic shocks, such as energy crises or sudden changes in household consumption levels." Woodford was asked whether there was a particular economic event or shock that demonstrated his new framework had indeed withstood the test. He cited the 2008 global financial crisis as an example, noting that at the time central banks faced weak demand, and cutting borrowing costs alone was not enough to solve the problem, so central banks adjusted their own policy tools. He said: "Forward guidance played an important role. That is, central banks explained more clearly the likely future direction of interest rate policy, rather than relying solely on further immediate rate cuts. This was an important component of the policy response at the time." "It did help improve economic stability. It didn't magically solve all problems, but I think it was an important contribution." Hall Reverses the Research Approach: Household Consumption Cannot Be Predicted in Advance In macroeconomic research, household consumption has always been one of the most important variables. Traditional theory generally holds that when household income rises, consumption rises accordingly. But economists have found that real-world household consumption behavior is far more complex. For example, even if a household's income does not grow this year, if it expects income to rise substantially in the coming years, it may increase consumption in advance. Conversely, even if current income is high, a household may choose to save more if it fears future unemployment. This means that what determines consumption is not only current income but also people's judgments about the future. The problem is that expectations about future income are very difficult to observe and measure directly. For a long time, economists searched continuously for indicators that could reflect household expectations, hoping to use them to predict changes in consumption, yet they were never able to achieve satisfactory results. In 1978, Hall proposed a different research approach. He argued that if households do indeed arrange consumption based on expectations of future income, then the current level of consumption has in fact already reflected the information households possess. Only when new information emerges and changes households' judgments about the future does the consumption plan need to be adjusted. And genuinely new information, by its very nature, cannot be predicted before it appears. From this, Hall drew a seemingly counterintuitive conclusion: if the theory holds, changes in household consumption should not themselves be systematically predictable in advance. This changed the direction of the research question. Economists no longer needed to search for indicators that could accurately predict changes in consumption; instead, they could test whether existing variables could systematically predict future changes in consumption. Hall's research provided important empirical support for this theory and established a benchmark for subsequent consumption research. In 1982, he and economist Frederic Mishkin further conducted research using household microdata and found that about 80% of households in the sample behaved in accordance with the relevant theory, while the remaining households were closer to a state of relying on current income to cover daily expenses. These findings helped economists understand why the same fiscal or monetary policy can have different effects on different households. Woodford Builds a New Model: Why Is Central Bank Expectation Management So Important? If Hall helped economists understand how households decide on consumption, then Woodford further integrated household expectations, firm pricing, and central bank interest rate policy into a unified macroeconomic framework. In 2003, Woodford published a work systematically expounding New Keynesian theory, and the macroeconomic model built on microeconomic foundations became an important template for subsequent research. The core of this model is to view the macroeconomy as the result of interactions among a large number of households and firms. Households decide on consumption and saving based on income expectations and interest rates, firms decide on the selling prices of goods based on production costs, market demand, and expectations of future prices, and the central bank influences these behaviors through interest rate policy. One important concept is the natural rate of interest, that is, the interest rate level that neither stimulates nor restrains economic activity. When the policy rate is below the natural rate, borrowing and current consumption may be stimulated; when the policy rate is above the natural rate, consumption and investment demand may be restrained. But Woodford's research further pointed out that the way central banks influence the economy is not limited to the current interest rate level. How people believe interest rates will change in the future can likewise alter today's economic decisions. For example, if firms expect that future production costs and the prices of other goods will rise, they may adjust prices in advance even if current costs have not yet risen noticeably. If households expect future interest rates to fall, their saving and consumption decisions may also change in advance. Therefore, whether a central bank can clearly and credibly explain its policy objectives and future actions to the market plays an important role in stabilizing economic expectations. This also provided the theoretical basis for modern central banks' strong emphasis on policy statements, interest rate guidance, and inflation expectations. Another important contribution of Woodford's model is that it helps economists distinguish the different effects of demand changes and supply shocks on the economy. For example, when oil prices suddenly rise, firms' production costs increase, and the goods and services the economy can provide may decrease. Even if consumers do not increase spending, economic demand may still appear too high relative to the reduced production capacity, thereby driving inflation. In such a case, simply stimulating consumption may further widen the supply-demand imbalance, while raising interest rates and moderately restraining demand may help control inflation. Through concepts such as the output gap, Woodford compared actual economic output with the natural level of output, providing an analytical tool for judging whether economic demand is too strong. This framework enables policymakers to analyze more systematically the effects of rising energy prices, supply chain disruptions, and other external shocks.