2026 Nobel Prize in Economics: What exactly should be done to stimulate consumption?
If the question raised by Keynes nearly a century ago was "What can the government do when the entire economy falls into recession", the task of economists of the generation of Hall and Woodford is to re-answer this question after going through the rational expectations revolution. The answer they give is: to stabilize the macroeconomy, we must first understand the people that make up the macroeconomy.
On October 12, 2026, the Royal Swedish Academy of Sciences announced that this year's Nobel Prize in Economic Sciences is awarded to Robert E. Hall of Stanford University and Michael Woodford of Columbia University, in recognition of their contribution to "laying the microeconomic foundation for macroeconomic stability". This is a combination that well summarizes the evolution of macroeconomics over the past half century. Hall studies why households consume and why enterprises hire people, while Woodford studies why enterprises cannot adjust prices at any time and how central banks affect the economy through interest rates and expectations. The work of the two eventually converges to the same direction: to understand why the entire economy prospers and recedes, and how the government stabilizes it, we must first understand how households and enterprises make choices when facing the future.
This is precisely the most important transformation in macroeconomics after the 1970s. Traditional Keynesian models are good at describing the aggregate relationships between consumption, investment, inflation and unemployment, but often do not further explain why these relationships hold. When the oil crisis, stagflation and the Lucas Critique came one after another, this approach was severely challenged. If households and enterprises know how the government will act, they will change their consumption, savings, pricing and wage demands in advance; the relationships observed in past data may not continue to hold under new policies. For stabilization policies to regain a firm foothold, macroeconomics must move down from "aggregate relationships" to individual choices, and then rebuild the entire macro system from individual choices.
Hall and Woodford have respectively completed extremely important parts of this project.
Source: Official website of the Nobel Prize
Hall: From Consumption to Unemployment
Robert E. Hall was born in 1943 in Palo Alto, California, a city that later became the center of Silicon Valley and almost the geographic center of his entire academic career. He completed his undergraduate studies at the University of California, Berkeley, then went to the Massachusetts Institute of Technology to pursue his doctorate under the supervision of Robert Solow, and received his doctorate in economics in 1967. After that, he taught at MIT and UC Berkeley successively, and joined Stanford University and the Hoover Institution in 1978.
Hall rarely refers to himself as a macroeconomist of a certain school. The introduction on his personal homepage even only has a very simple sentence: "I am an applied economist", whose interests include employment, inflation, technology, competition and economic policy. This sentence well summarizes his research style. He did not build a grand system named after himself, but kept putting forward new research methods on many key issues such as consumption, labor market, enterprise pricing, productivity, tax system and business cycle.
He even left a name for the famous "freshwater-saltwater" debate in modern macroeconomics. Hall recalled that in a paper in 1976, he took the lead in using the terms "freshwater school" and "saltwater school" to distinguish different macroeconomic traditions near the Great Lakes in inland United States and on the east and west coasts. Later, these two slightly playful terms unexpectedly became commonly used labels for the debate between neoclassical macroeconomics and New Keynesian school. More interestingly, this year's Nobel Prize grouped the economist who once "named" the two schools together with Woodford, one of the most important theorists of New Keynesianism.
Hall's most classic work was published in 1978, titled *Stochastic Implications of the Life Cycle-Permanent Income Hypothesis: Theory and Evidence*.
Friedman had previously put forward the permanent income hypothesis: people will not spend all the extra 1,000 yuan they earn suddenly this month immediately, and what really determines consumption is the judgment of long-term income. Hall took a step forward: if consumers are rational and can use existing information to predict the future, what statistical properties should consumption changes have?
The answer seems a bit surprising. Assuming that a household has incorporated all the information it can know today into its lifetime income expectation, then the news that can be predicted today should theoretically have been reflected in today's consumption long ago. Therefore, tomorrow's consumption only needs to be adjusted when new, unpredictable information that cannot be known today appears tomorrow. If there is no new news, consumers have no reason to suddenly change their consumption. Thus, under specific assumptions, consumption is approximately a random walk process, and its changes should be difficult to predict with existing information.
This result is very unexpected, so it has aroused a lot of suspicion. According to *Advanced Macroeconomics* written by Romer, when Hall first reported this paper, a famous macroeconomist told him that he "must have taken drugs" when writing this paper.
However, it is precisely such a maverick conclusion that has changed the way macroeconomics studies consumption. Since then, researchers can no longer be satisfied with simply writing an empirical equation of "when income increases by a certain amount, consumption increases by a certain amount", but need to deduce consumption behavior starting from the intertemporal optimization of consumers. The Euler equation, which is ubiquitous in later macro models, is exactly the basic tool of this research tradition. Hall's 1978 paper has thus become one of the landmark works of establishing the "micro foundation" of macroeconomics after the Lucas Critique.
Subsequent studies of course found that consumption in the real world does not completely follow the law of random walk. Households may face liquidity constraints, have precautionary savings, and may also have problems such as habit formation and bounded rationality. But this does not weaken the importance of Hall's method. On the contrary, subsequent consumption theories often first ask: why does reality deviate from Hall's theoretical benchmark? This research method of "first deducing the benchmark from optimization, and then explaining the deviation" has become the standard routine of modern macroeconomics.
Hall later extended similar methods to the labor market. This is especially important for understanding the "macroeconomic stability" mentioned in this year's Nobel Prize.
There is a long-standing confusing fact about the business cycle: during economic recession, employment and job vacancies can drop sharply, and the unemployment rate rises significantly, but wages often do not drop by a corresponding margin. If the labor market operates like a simple supply and demand model, the increase in unemployment should push wages down rapidly, enterprises will be willing to hire people again, and unemployment should not last for so long.
The Diamond-Mortensen-Pissarides search and matching theory explains that workers and enterprises need to spend time looking for each other, but the standard model once still struggled to generate unemployment fluctuations as large as in reality. One of the focuses of Hall's research is to explain why wages do not easily absorb such shocks.
In 2008, he and Paul Milgrom proposed a new wage negotiation mechanism. Once enterprises and workers have found each other, the cost of re-looking for another partner is usually very high. Therefore, the really important threat in the negotiation process may not be "I will leave immediately if we fail to reach an agreement", but more the cost of delaying the negotiation itself. In this way, the impact of external unemployment changes on negotiated wages will be much smaller than that in the standard model. Wages are relatively stable, so corporate profits and willingness to recruit will be more sensitive to economic shocks, and small productivity changes may also cause large changes in job vacancies and employment.
Consumption research and labor market research seemingly belong to two fields, but they share a common logic: consumption, employment and unemployment in the macroeconomy cannot only be written down as several historical statistical relationships. We must ask why households consume in this way, why enterprises recruit in this way, and why workers accept such wages. Macroeconomic fluctuations must eventually grow out of micro choices.
This kind of research also makes Hall one of the few people who are active in both macro theory and real cycle judgment. From 1978 to 2013, he led the Economic Fluctuations and Growth Research Program of the National Bureau of Economic Research (NBER) for a long time, and served as the chairman of the NBER Business Cycle Dating Committee all the time. The "semi-official" judgment that the United States enters and exits a recession at what time, which is constantly quoted by the media, has long been made by the committee led by Hall. In 2010, he also served as the president of the American Economic Association.
Woodford: Did Not Abandon Keynes
Compared with Hall, Michael Woodford's academic path is more unusual. He was born in 1955 in Chicopee, Massachusetts, graduated from the University of Chicago for his undergraduate study, and then did not immediately pursue a doctorate in economics, but entered Yale Law School and obtained a Juris Doctor (J.D.). After that, he transferred to the Massachusetts Institute of Technology and received his doctorate in economics in 1983. In 1984, he first joined Columbia University to teach, and later worked at the University of Chicago and Princeton University, and returned to Columbia again in 2004.
Woodford later became one of the most systematic theorists in modern monetary economics. What his research really answers is a seemingly simple question: why can central banks affect trillions of dollars of consumption, investment, employment and prices only by changing a very short-term interest rate?
Traditional monetarism likes to answer this question from the perspective of money quantity. But by the 1990s, the core of the actual operation of many central banks gradually shifted from controlling money supply indicators such as M1 and M2 to adjusting short-term policy interest rates. Monetary economics needs a new theory that matches the operation mode of real central banks.
What Woodford did is exactly to establish this set of theories.
The most important point to understand Woodford is: he did not try to go back to the old Keynesianism of the 1960s.
The Lucas Critique holds that if the government changes the policy rules, households and enterprises will also change their expectations and behaviors, so the effect of new policies cannot be mechanically predicted based on past statistical correlations. Woodford fully accepts this point. His model also starts from rational, forward-looking households and enterprises, letting consumers carry out intertemporal optimization and letting enterprises determine prices according to future profits. The difference is that he retains a very important friction in the real world at the same time: prices cannot be readjusted at all times without cost. In this way, rational expectations and price stickiness enter the same model.
In the 1990s, Woodford, Julio Rotemberg and others further developed a monetary policy model based on optimization behavior. The Rotemberg-Woodford framework in 1997 was already very close to the New Keynesian DSGE model that later became the standard tool of central banks: households optimize consumption and savings, enterprises set prices under monopolistic competition but can only adjust prices from time to time; central banks affect aggregate demand and inflation through short-term interest rates.
This is equivalent to completing a "reconciliation" in macroeconomics. Lucas is right: we cannot ignore expectations, nor can we use historical relationships lacking behavioral foundations to evaluate new policies. But Keynes also captured a real phenomenon: there are adjustment frictions in prices and wages, so changes in demand can indeed affect production and employment in the short term.
Modern New Keynesianism is thus no longer a simple revival of old Keynesianism, but a Keynesianism re-established after absorbing the rational expectations revolution.
How Central Banks Manage the Future
In 2003, Woodford published the nearly 800-page book *Interest and Prices: Foundations of a Theory of Monetary Policy*. The title directly pays tribute to the book *Interest and Prices* written by Swedish economist Knut Wicksell. This book later became one of the most important works of modern monetary policy theory, and Columbia University also called it Woodford's most important work.
The most important idea of this set of theories is to push monetary policy from "controlling today's interest rate" to managing people's expectations of future interest rates. Whether an enterprise invests in building a factory does not depend on what today's overnight interest rate is, but on the financing cost for many years in the future; whether a household buys a house will not only consider the immediate interest rate. Therefore, the power of central banks to truly affect the economy largely comes from whether they can change the public's judgment on the future policy path.
This is why a word from the central bank can sometimes push market interest rates down before the actual interest rate cut. As long as enterprises and households believe that the central bank will maintain low interest rates in the future, they will change their consumption, investment and pricing today. Thus, communication itself becomes a monetary policy.
The later widely popular "forward guidance" is exactly the practical expression of this idea. The Royal Swedish Academy of Sciences specially emphasized in this year's note that Hall and Woodford's model puts the forward-looking behavior of households and enterprises at the center, and the government and central banks can change such expectations by explaining future policies, thus affecting today's economic activities.
Woodford also promoted another important transformation of modern monetary theory: monetary policy does not necessarily need to be explained by controlling the quantity of money.
In his "cashless economy" framework, even if money balances themselves hardly play a role, central banks can still affect the real interest rate by setting the short-term nominal interest rate, thus changing consumption and investment. The key variable thus changes from "how much money there is" to the gap between the market real interest rate and the natural interest rate.
This brings Wicksell's idea of natural interest rate put forward a hundred years ago back into modern macroeconomics. If the market real interest rate is lower than the natural interest rate that keeps the economy at potential output and stable inflation, demand will expand; otherwise, demand will contract. The task of the central bank is to adjust the interest rate systematically according to changes in inflation and economic activities.
The Taylor rule provides such a simple rule in practice, and Woodford further explains why this rule can stabilize the economy. One of the important conditions was later called the Taylor principle: when inflation rises by 1 percentage point, the central bank should raise the nominal interest rate by more than 1 percentage point to make the real interest rate rise truly. Otherwise, the rise in inflation may reduce the real interest rate, further stimulate demand, and the economy may lose its stable anchor.
Therefore, Woodford's work puts the natural interest rate, interest rate rules, rational expectations, price stickiness and central bank credibility into a unified framework.
Looking for Micro Foundation for Macroeconomic Stability
At first glance, this year's combination is somewhat unexpected. Hall is most famous for consumption theory and labor market, while Woodford is most famous for monetary policy. The two are not a pair of economists who have cooperated for a long time.
But from the perspective of the history of macroeconomic thought, this combination is actually very complete. Hall answers: how do households and workers act when facing the future? Woodford answers: how do enterprises set prices, and how do central banks affect these actions by changing future conditions?
The former establishes the micro foundation of consumption and labor market for macro models, while the latter links these forward-looking behaviors with nominal price frictions and monetary policy. The two lines of work have jointly changed the meaning of stabilization policies in the end.
Traditional stabilization policies more or less have a hint of "pulling a lever": when unemployment is high, increase demand; when inflation is high, reduce demand. Modern macroeconomics tells policymakers that people in the economy are not passive pawns waiting for the government to manipulate. Households will predict future taxes and income, enterprises will predict future demand and interest rates, workers will consider future employment opportunities, and everyone will also guess what the government will do next. Policies change behaviors, and people's expectations of policies will change behaviors in advance. This is the real meaning of "micro foundation".
From the perspective of the 1970s, the rational expectations revolution once seemed to mean the end of Keynesian stabilization policies. If households and enterprises can foresee policies, the government's ability to simply manipulate aggregate demand will be greatly reduced. Macroeconomics has therefore undergone decades of reconstruction.
Hall is an early participant in this reconstruction. He really brought rational expectations into consumption theory, and kept looking for micro foundations for consumption, labor market and business cycle. Woodford belongs to the generation that completed the synthesis later. He did not abandon rational expectations, but put price stickiness and monetary policy back into a strict general equilibrium system.
Therefore, the 2026 Nobel Prize does not simply reward "Keynesianism", nor does it reward a specific interest rate cut or fiscal stimulus policy. It rewards a new macroeconomic approach: starting from purposeful, forward-looking households and enterprises, re-establishing the theory of how the entire economy fluctuates and how policies stabilize it.
The Royal Swedish Academy of Sciences made