STOCKHOLM, Oct. 12 (Xinhua) -- Imagine receiving an extra 1,000 U.S. dollars this month, would you spend it differently if it were a one-time bonus rather than a permanent monthly pay raise?
The distinction may seem simple, but it lies at the heart of research that earned Robert E. Hall and Michael Woodford the 2026 Nobel Prize in Economic Sciences on Monday "for microeconomic foundations of macroeconomic stabilization," according to the Royal Swedish Academy of Sciences.
Behind the technical wording is a simple idea: to understand how an entire economy works, economists must first understand how households decide what to spend and businesses decide what to charge.
WHAT DID THE LAUREATES DISCOVER?
Hall helped explain why the relationship between income and consumption is more complicated than traditional economic models have assumed.
People generally prefer to maintain relatively stable spending over time, rather than dramatically changing their consumption whenever income rises or falls. Their decisions therefore depend partly on what they expect to earn in the future.
That helps explain why a one-time bonus and a permanent pay raise may lead to different spending decisions. Whether the extra income was expected also matters.
In a 1978 study, Hall argued that if households already incorporate all available information into their spending plans, changes in consumption should largely depend on new, unexpected information.
For example, a long-anticipated pay raise may already have influenced someone's spending decisions before the money arrives. An unexpected job loss, however, could force an immediate reassessment.
The distinction matters for policymakers: the impact of tax cuts or government payments depends not only on how much money households receive, but also on their expectations and financial circumstances.
Woodford, meanwhile, helped explain how businesses' pricing decisions, together with household consumption, shape the broader economy.
At Monday's Nobel announcement, an ice cream price illustrated the point. An ice cream seller may set prices for an entire season because changing them repeatedly costs time and money, such as printing new menus.
Economists call this phenomenon "sticky prices," meaning that prices do not immediately adjust to changes in demand or production costs.
Because prices may remain unchanged for some time, businesses must also consider future costs and competitors' prices when setting them. When demand weakens and prices remain fixed, businesses may respond by reducing production and employment.
Woodford's 2003 book presented a New Keynesian macroeconomic model built on microeconomic foundations, bringing together household decisions based on expectations about the future, sticky prices and interest rate policy.
WHY DO THEIR DISCOVERIES MATTER?
Traditional Keynesian models had long guided economic stabilization policies, such as lowering interest rates and increasing government spending during recessions.
However, the oil crises of the 1970s exposed their limitations, as inflation rose alongside unemployment and challenged previously assumed relationships between key economic variables.
Hall and Woodford's research helped lay the foundation for a new generation of models showing how government and central bank policies can influence household and business decisions.
By incorporating expectations about the future, these models also showed why communicating policy intentions can be an important tool for economic stabilization.
Speaking to reporters after winning the prize, Woodford pointed to the 2008 global financial crisis, when conventional interest-rate cuts proved insufficient to restore economic activity.
One alternative was "forward guidance," through which central banks communicate how they expect interest rates to evolve.
Such announcements can influence households' spending and businesses' investment decisions even before interest rates change.
The models have also helped policymakers better understand economic shocks, including sudden increases in energy prices that can push inflation higher while slowing growth.
"The laureates' work has provided us with a stable theoretical foundation for the models that are now used by central banks and governments around the world," John Hassler, chair of the Committee for the Prize in Economic Sciences, said.
For policymakers, understanding decisions about household budgets and business prices can help them respond to economic shocks and soften the economy's ups and downs. ■
