The Nobel Laureate, Daniel Kahneman, took us on a groundbreaking tour of the mind and explained that two systems drive the way we think. System 1 is fast, intuitive, and emotional and somewhat impulsive; System 2 is slower, more deliberative, and more logical. Kahneman exposed the extraordinary capabilities—and also the faults and biases—of fast thinking, and revealed the pervasive influence of intuitive impressions on our thoughts and behaviour. The impact of loss aversion and overconfidence on corporate strategies, the difficulties of predicting what will make us happy in the future, the challenges of properly framing risks at work and at home, the profound effect of cognitive biases on everything from playing the stock market to planning the next vacation—each of these can be understood only by knowing how the two systems work together to shape our judgments and decisions. There are some situations where we can and sometimes cannot trust our intuitions, and we can tap into the benefits of slow thinking, which psychologists say “respond but do not react”. By regularly analysing how choices are made in both our business and our personal lives—and how we can use different techniques to guard against the mental glitches that often get us into trouble- we can win.
Yesterday’s Nobel Laureates, Robert E. Hall and Michael Woodford, have gone beyond Kahneman and have created a paradigm shift in Market stabilisation policies, based on the same Microeconomic foundations, using more of System 2 where response depends upon expectations of the future. Robert Hall’s central idea was that household consumption is determined by their expectations of the future; if they are optimistic, they will consume more, but if they are pessimistic, they will consume less. Nowadays many job holders are pessimistic that automation would take away their jobs and are reducing their consumption basket and the situation is just the reverse in highly skilled people and highly wealthy people. Therefore instead of using algorithms to forecast household consumption, we should try to understand that we should understand that it is not possible to do so. People at the bottom of the economy, living from hand to mouth, will never increase their consumption demand, even if they get freebies. The learning point is that some households are forward-looking while determining their consumption basket, but others are not; this is being used nowadays to frame Macroeconomic policies.
Michael Woodford, in his pioneering work, again came to Microeconomic foundations and the Human Mind. He added that if Interest rates were low, Savings would be less attractive and Consumption would be more attractive. Researchers add that if Savings had no financial benefits, say tax benefits, people would have a tendency to consume more and save less. Only forward-thinking people would save more, worrying about their post-retirement lives. Michael Woodford also shed light on the Corporate Mind, especially the mind of the Marketing Manager. It is difficult to change prices every time demand or production costs change. So corporates, especially FMCG, have devised a unique policy: while keeping the price sticky, they have reduced the quantity on offer. If businesses do adjust a price, they have some expectation behind it-just as their own cost increases are forcing a price revision, their competitors will do likewise. Woodford also introduced the concept of the output gap, to describe the demand pressure in the economy; higher demand pressure would create a positive output gap, while lower demand pressure would create a negative output gap, which we call an economic downturn. The task of stabilisation is to move the output gap towards zero. However, a force majeure condition here is sudden supply shocks like the Iran war, which has led to a global increase in energy prices and, to some extent, a fall in the lower-income group. Woodford’s model recommends a cooling measure, such as interest rates, to avoid uncontrolled inflation.
We greatly appreciate the contributions of these 3 Nobel Laureates to macroeconomic policy.