Finn Kydland on his work and Ireland

I was going through this old interview of Finn Kydland, 2004 Laureate  alongwith Ed Prescott.

He nicely explains his work and why he got the Nobel Prize:

Q. Can you give us a layperson’s version of the work that won you the Nobel?

A. The shortest way to describe it is that Ed Prescott and I showed how to put people into economic models and therefore policy. The award was for work we did in the mid- to late 1970s. In those days, macroeconomic models tended to be systems of equations in which researchers used statistical techniques to determine the parameters for consumption functions, investment functions, labor supply functions, labor demand functions and so on.

Around 1973, a two-page story in BusinessWeek expressed excitement about the idea you could use optimal control theory, a tool applied in physics, engineering and other sciences, to control the aggregate economy. This was just around the time that Prescott and I started our work, and we basically showed that using such techniques in that context isn’t a good idea.

Q. What’s the better idea?

A. We were explicit about the decisions facing rational people. Many of the most important decisions are very forward-looking—accumulating physical capital, accumulating human capital, buying long-term bonds and so on. We included these kinds of decisions in our models.

We put our framework to use in several contexts, and we actually won the Nobel Prize for two things. One was the application of our framework to business cycles, where we supposed there were no other sources of change beyond technological shocks that raise productivity. How much of the business cycles still remained? We determined that these kinds of shocks account for about two-thirds of post–World War II economic fluctuations.

The Nobel committee also mentioned the time inconsistency of optimal policy. Being explicit about households’ and businesses’ decisionmaking allows you to incorporate the fact that so many important decisions are forward-looking. They depend, for example, on what decisionmakers think the government is going to do in the future. An optimal policy would have to take into account the effect of future policy on current decisions.

When that future arrives, those decisions have already been made and there’s an unfortunate incentive for governments to abandon the optimal policy and replace it with one that is better only under the naïve assumption that households and businesses won’t see it coming. If the public anticipates the policy switch, the government is forced to implement a policy that is time consistent—there’s no incentive to later repudiate it—but potentially much worse than the time-inconsistent policy.

Hmm.. The time inconsistency is well-know and explained. Their work on business cycles needed better understanding.

This view on Ireland is what caught my eye:

Q. What are your research interests these days?

A. They go along several lines. I’m still interested in studying particular nations. I’ve looked at Argentina, and it’s a great contrast to a country like Ireland. I think there’s a lot to learn from a very successful nation like Ireland and why in other cases, things go so disastrously wrong, as they’ve done in Argentina.

So may got their verdict on Ireland wrong. Its image of Celtic Tiger was just so overstated. It decline has been an extraordinary journey. Patrick Honohan of Ireland Central Bank tells you it was just credit driven growth and Ireland just did not learn lessons from its  past and kept borrowing.

But then so many got their verdict on SE Asian tigers wrong which together but the dust in 1997-98 crisis.

One way to forecast the next country in crisis would be to see which country is currently being referred to as tiger…May be its time has come…

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