Stanford and Columbia economists Robert Hall and Michael Woodford win the Nobel prize in economics

The Royal Swedish Academy of Sciences announced the prize in Stockholm on Monday, the Associated Press reported. It goes to Robert E. Hall of Stanford University in California, and Michael Woodford of Columbia University in New York, “for microeconomic foundations of macroeconomic stabilisation.” They share it equally.

In plainer words, they worked out how a government or a central bank should respond when something hits the economy, an oil shock, a burst of inflation, a slump, so that a downturn does not turn into a long recession and a boom does not run away.

The idea of smoothing out booms and busts goes back to Keynes. For decades it meant cutting interest rates and running a deficit in a slump, and the opposite in a boom. Then came the oil crises of the 1970s. The old models stopped working. Unemployment stayed high and inflation took off anyway, and the West had a decade of both at once. A lot of economists concluded that trying to steady an economy did more harm than good, and that the whole idea should be dropped.

Hall and Woodford showed how the models could be rebuilt from the ground up, starting with how real households and firms decide whether to spend or save and how they set prices and wages. Those are the models that central banks and finance ministries use today when they decide whether to raise rates or spend.

“The laureates’ research has made it possible to manage major macroeconomic crises far more effectively than before,” the academy said.