Marginal Revolution has four posts on this year's Nobel Prize winners

Michael Woodford Wins Nobel by Alex Tabarrok

Robert E. Hall, Nobel Laureate by Tyler Cowen

Michael Woodford, Nobel Laureate by Tyler Cowen

The Nobel Prize Goes to Robert Hall and Michael Woodford by Alex Tabarrok

Here is an excerpt from this last post that has some material students might know:

"Hall has an unusual number of unexpectedly creative papers. His best known is on consumption.

Start with the textbook Keynesian model: Y = C + I + G + NX. Consumption is the biggest piece of Y and it also depends on Y, so C and Y have to be solved together. The consumption function was the engine of the Keynesian multiplier. The simplest version was C = a + bYd, where Yd is disposable income. Economists estimated b, forecast Y and used the forecast to predict C. Get b, the marginal propensity to consume (MPC), wrong and you get fiscal policy wrong; so a lot of work went into estimating the MPC.

Hall began instead with Milton Friedman’s permanent income hypothesis. Consumption today should depend not just on today’s income but on a consumer’s expected lifetime or permanent income. Hall added rational expectations, so people estimate their permanent income using everything they know. Many economists already accepted both ideas but Hall showed that together they imply something surprising. Consumption should follow a random walk!

Suppose you learn today that you will get a large, permanent raise starting next January. If you can save and borrow, you should start spending more today. When January’s bigger paycheck arrives, it isn’t news. You already knew it was coming.

So information that predicts your income should not predict changes in your consumption. Expected changes in income are already built into your spending plans, and only surprises cause revisions. In the simplest case (quadratic utility, free borrowing and saving, and an interest rate that just offsets impatience) the theory gives

E_t(C_t+1 − C_t) = 0

Given what you know today, your best guess for the change in consumption is zero. Consumption moves only on news. Past income or any other variable shouldn’t help predict tomorrow’s consumption once you know today’s consumption.

The key point is that Hall’s test didn’t need a model of how people forecast income. The old consumption functions used things like a distributed lag on past income as a stand-in for expected future income. Hall asked a different question: does anything known today predict the change in consumption tomorrow? He found that the theory was surprisingly correct! Consumption looks like a random walk. Changes in consumption are unpredictable. Later work found consumption somewhat more predictable than Hall’s strict version allows, but the random walk became the benchmark everyone measures deviations from.

Related posts:

What do Nobel Prize Winners Muhammad Yunus and Edmund Phelps Have in Common?  (2006)

What The 2010 Nobel Prize Winners Studied (2010) ( Peter Diamond, Dale Mortensen, and Christopher Pissarides)

Some Information On This Year's Winners Of The Nobel Prize In Economics (2011) (Thomas Sargent and Christopher Sims)

Angus Deaton Wins The 2015 Nobel Prize In Economics  (2015)

Some Information About This Year's Winners Of The Nobel Prize In Economics (2016) (They are Oliver Hart and Bengt Holmström.)

Nobel for Economics Awarded to Authors of ‘Why Nations Fail’ and an Ex-IMF Figure: Daron Acemoglu, Simon Johnson and James Robinson are honored for their work on how institutions form and affect differences in prosperity (2024) 

Marginal Revolution has great posts on this year's winners of the Nobel Prize in economics (Philippe Aghion, Peter Howitt and Joel Mokyr): This is a prize for economic growth & creative destruction (2025)