On Monday, the Royal Swedish Academy of Sciences awarded this year’s Nobel Prize in Economics to Robert Hall (Stanford University and the Hoover Institution) and Michael Woodford (Columbia University) for their work on the “microeconomic foundations of macroeconomic stabilization.”
There are already several excellent articles summarizing the laureates’ contributions to economics. Some particular favorites are Brian Albrecht’s first-rate explanation of how their work fits within and transformed the broader macroeconomics literature, Tyler Cowen and Alex Tabarrok over at Marginal Revolution, and David Henderson writing in The Wall Street Journal.
Whenever the Nobel is announced, we are invariably asked to summarize the work it recognizes into a soundbite. James Buchanan won in 1986 for explaining that politicians are people and they respond to incentives. Ronald Coase won in 1991 for pointing out that finding a trading partner and signing a contract are costly. Elinor Ostrom won in 2009 for demonstrating that communities can work together to take care of the resources nearby. Peter Diamond, Dale Mortensen, and Christopher Pissarides won in 2010 for pointing out that economic policy can cause unemployment to last longer. This year’s prize can be summarized in two words: expectations matter.
When non-economists hear these summaries, they think, “Why on earth do you need a PhD to know that? I could have told you that myself! How come I’m not getting a Nobel Prize?”
They’re not wrong. Anyone can tell you these things, and plenty of people have in the course of their everyday lives. But it takes amazingly intelligent and clever people to demonstrate these insights empirically, explain why they are important, and point out what further questions can be gleaned from those initial insights.
So let’s take “expectations matter” and explain why this is important, and what further implications that simple insight has on our understanding of the world.
The first thing we can learn is that, if expectations matter, then people are not looking just at the world today. They are also forecasting what the future might look like, albeit imperfectly. The future might be unknowable, but that does not mean it’s completely unimaginable. I know that later on tonight, my wife and I will put our kids to bed. I don’t know exactly how well that process will go, but I can promise you that it will be nothing like The Sound of Music. Later today, after we pick them up from school and see how they’re doing, we’ll have a better idea of how that process will go and can make adjustments to the evening’s activities in light of that new information.
This matters not just in the household, but in the broader economy as well. If consumers, for example, think that the economy is going to do poorly in the future, then they will behave differently today than if they thought things were going to be amazing. They might decide to hold off on some purchases they would otherwise make, in order to ensure that they have cash for potential Bad Times that might be coming. Likewise, if we’re very confident that things are going to go well, we might be like Clark Griswold and use some of that future money today through borrowing. That is a tremendous insight and helps us understand why economists and policymakers look at measures like consumer sentiment and small business optimism so closely.
But notice what it also means: if consumers are basing today’s spending decisions on projections about the future, then a stimulus check shouldn’t really shouldn’t have a large macroeconomic effect, because it doesn’t move the needle on how people are feeling about the future. So what does “expectations matter” imply about what people will do with a stimulus check? It predicts that they’ll probably save a good portion of that check for the future or use it to pay down debt. Lo and behold, this is basically what happened with the CARES Act checks that were issued during COVID. Those checks didn’t change the fact that we were in a pandemic and that governments around the world had essentially closed borders and locked down large sectors of the economy. The stimulus money didn’t affect people’s expectations about the future.
If governments want to stimulate the macroeconomy, then, they need to consider what people expect to happen in the future. For example, Zimbabwe experienced hyperinflation during the early 2000s, peaking at 79.6 billion percent inflation per month. How did things get so bad? Part of the answer comes from the insight that “expectations matter.” The economy in Zimbabwe was not exactly doing great, even in the 1990s. To address this, the central bank began printing money, accelerating inflation. Because the people of Zimbabwe came to expect that their central bank was going to inflate the currency, they started baking that expectation into their forecasts about the future. Once that happened, the central bank had to exceed the people’s expectations if they wanted to have any stimulative effect. And once people saw that their expectations were too low, they adjusted them again, meaning that the central bank had to go even more in excess of expectations. Once this is understood, Zimbabwe’s experience, while tragic, becomes understandable.
The last implication of this year’s prize that I’ll go over is that credibility matters. A government that announces that they’re going to do something in the future affects people’s behavior today. The government then faces a choice: they can do that thing, in which case it will show that they are credible but it will have very little macroeconomic effect, or they can do something different, which will produce a short-run jolt but will strain their credibility going forward.
Few areas of policy illustrate this better than trade over the last two years. Since January of 2025, tariffs have been announced, threatened, paused, raised, delayed, and cut at a pace that can only be described as “frantic.” As a result, America’s credibility has been strained on the world stage, making it harder to secure any form of trade deal. When people do not believe what the government is saying, that uncertainty itself has a deterrent effect on economic activity. If there is one thing that we have learned, it’s that long-term growth requires long-term plans and long-term plans require credibility.
So yes, “expectations matter.” Everyone already knew this and, thanks to Hall and Woodford, so do economists.
