When a central bank raises or lowers its interest rate, the people in the room rarely reach for a ruler and a scatter plot. They run a model, and in nearly every finance ministry and central bank on the planet, that model carries the fingerprints of two American economists who have now been honoured with the 2026 Prize in Economic Sciences. On Monday in Stockholm, the Royal Swedish Academy of Sciences named Robert E. Hall of Stanford University and Michael Woodford of Columbia University as this year’s laureates, citing their work on the “microeconomic foundations of macroeconomic stabilisation.”
The phrase sounds forbidding, but the idea behind it is easy to state. For decades, economists tried to steer national economies by watching how big aggregate numbers moved together, such as inflation against unemployment, or total income against total spending. Hall and Woodford argued, in very different ways, that those big numbers are only the sum of countless small choices made by families deciding what to buy and companies deciding what to charge. Get those small choices right, they reasoned, and the big picture becomes far more dependable.
The two will split the prize money of 12 million Swedish kronor equally. Hall was born in 1943 in Palo Alto, California, and earned his doctorate at the Massachusetts Institute of Technology in 1967. Woodford, born in 1955 in Chicopee, Massachusetts, finished his own MIT doctorate in 1983. Their work has had its most visible effect far from campus, inside the institutions that set borrowing costs for hundreds of millions of people.
To understand why the award matters, it helps to go back half a century. The toolkit inherited from John Maynard Keynes rested on a simple promise: when demand is weak, governments and central banks can pump it up, and when it runs too hot, they can cool it down. Then the oil shocks of the 1970s arrived, and the old rules of thumb broke. Prices kept climbing even as joblessness rose, a combination the standard models said should not happen. Policymakers added stimulus at exactly the wrong moments, and much of the Western world endured years of sluggish growth alongside stubborn inflation.
The critique that followed, led by the late Robert Lucas, held that the relationships economists relied on were not laws of nature. They shifted whenever people changed their behaviour, often because policy itself had changed. The challenge was to build something sturdier from the ground up, yet simple enough for real policymakers to use.
Hall’s contribution, published in 1978, tackled a key piece of that puzzle: how households decide how much to spend. Economists suspected that spending depends heavily on what families expect to earn in the future, but expectations cannot be observed directly, and years of hunting for clues had led nowhere.
Hall flipped the question around. If households really base their spending on their best guess about the future, he reasoned, then today’s spending already contains all the information they have. The only thing that should change their behaviour is genuinely new information, and new information is, by definition, impossible to forecast. So instead of trying to predict changes in consumption, economists should test whether those changes can be predicted at all. If the theory is right, they cannot.
The test largely held up, and its real value lay in the exceptions. Where spending could be predicted, it pointed to families who could not borrow or had no savings. In a 1982 study with Frederic Mishkin, Hall used household data to estimate that roughly four in five families behaved in the forward-looking way his theory described, while the rest lived from one payment to the next. That split remains a basic ingredient in today’s models.
From a three-equation model to everyday interest rate decisions
If Hall supplied a crucial building block, Woodford assembled the house. His 2003 book, “Interest and Prices,” pulled together a decade of research into a compact framework that came to define the New Keynesian approach. At its core sit three relationships: how households spend, how firms set prices, and how the central bank reacts. The framework gave policymakers something they had lacked since the 1970s, a laboratory in which to ask what happens to output and inflation if rates move by a quarter point, with answers grounded in how people actually decide.
Woodford placed Hall’s forward-looking households at the heart of the demand side. He also drew on the Swedish economist Knut Wicksell, who more than a century ago described a “natural” interest rate that neither speeds up nor slows the economy. Woodford showed that central banks could steer activity by setting rates relative to that neutral level rather than by controlling the money supply, which is how most of them now operate.
On the supply side, his model assumes companies cannot change prices every day. When they do adjust, they look ahead to where costs and competitors are heading. If firms base today’s prices on tomorrow’s expectations, then what a central bank says about its plans can matter as much as what it does. The modern habit of forward guidance and lengthy rate explanations owes much to this thinking.
Woodford also popularised the output gap, the distance between what an economy produces and what it could produce if prices adjusted freely. Keeping that gap near zero is the job of stabilisation policy. When supply shocks such as energy price spikes shrink capacity, older models often counselled more stimulus, while the New Keynesian framework could point toward tightening to stop inflation from becoming entrenched.
John Hassler, who chairs the prize committee, said the laureates had given central banks and governments a stable theoretical footing for dealing with shocks such as energy crises. Critics argue the models handled the 2008 financial crisis poorly, largely because early versions paid little attention to banks and debt. Researchers have since added financial frictions and unequal households, and the framework keeps evolving.
That adaptability may be the best argument for the award. Recessions and inflation scares have not disappeared, but the deep, decade-long slumps that once followed big shocks have become rarer. Somewhere in the reasoning behind your next mortgage rate, there is a good chance a version of the Hall and Woodford logic is quietly doing its work.
