What makes good policy?

One late evening in the Norwegian city of Bergen, two men are waiting at a bus stop. Their expressions carry focus and intent despite the time of day, and their discussion is clearly posing a predicament. A short while later, a curious bystander notices a change in their demeanor: a problem has been solved. The two men are economists Finn Kydland and Ed Prescott, and the idea that came to them at that bus stop would win them the Nobel Prize decades later.

Finn E. Kydland

The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel, 2004

At a glance

Born: 1943; Gjesdal, Norway

Field: Macroeconomics

Prize-winning work: Contributions to dynamic macroeconomics: the time consistency of economic policy and the driving forces behind business cycles

Letters on his car’s license plate: GDP

Biggest passion: Blues music

Favorite pastime: Playing guitar and taking guitar lessons

A magical moment

Kydland, a native of Norway, shares his story with excitement. By the time of the "a-ha moment" at the bus stop, Kydland and Prescott had been intensely focused for quite some time on the best way to model business cycles using various simplifying assumptions. One of the assumptions, for instance, involved an economy in which people are all alike and immortal. Then suddenly, waiting for the bus and away from the papers, "magically an idea pops into your cranium about something you were struggling with and then you make progress," Kydland says. In this case, the progress meant game-changing work in macroeconomics.

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How do you make politicians commit to the things they’ve promised?

Although it sounds profoundly theoretical, the work on time inconsistency and policy commitment delivers concrete implications and relevance for governance. "Good policy," the economist clarifies, "presumably would take into account the effect future policy has on earlier decisions. The problem is: when that future arrives, those decisions have already been made. Especially if a government finds itself in a bit of an emergency situation, which governments somehow often do, they’ll have an incentive to focus more on the short term and abandon continuation of their policy."

One reason policies are easily cast aside in times of turmoil is that economic policies (and fiscal policies in particular) are regulated by elected governments, and therefore the whim of the politicians in charge at the time. These policies are subject to change in the long run or are inconsistent. Politicians don’t always commit to policies once elected. Indeed, there is no conceivable way to make sure that their commitments matter. "Sometimes I joke that this is such an important problem, if some young hotshot economist comes up with a way to commit to good future fiscal policy, he will probably stand in front of the King of Sweden and receive a prize," Kydland says with a smile.

To make sure those in power stay dedicated to policies that are consistent over time, Kydland and Prescott focused on the regulation of monetary policy, which is a matter for central banks. The conclusion that followed from their groundbreaking work, suggests that central banks should be kept impartial to government pressure. Simply put, the work justifies the independence of central banks as the way to make sure the policies remain consistent over time.

Becoming an economist by accident

Kydland fell into his academic career by accident. His choices are atypical, if not somewhat rebellious considering his background. Coming from a longstanding farming family, Kydland’s father had been the first to break the mold and start a trucking business. Because he’d been excellent at math in school, Kydland later went on to attend the Norwegian School of Economics and Business Administration. He believed he had a career in business management ahead of him. That was up until his inspiring senior year seminar with Sten Thore. "If I hadn’t taken that seminar from him, I would have ended up with a very boring life. I didn’t know it at the time that it would be boring compared to what I ended up doing, but I was very grateful." One can’t help but wonder if an innovative, entrepreneurial spirit like Kydland’s is even capable of choosing a boring path.

Can economists contribute to treating Alzheimer’s disease?

Today, Finn Kydland is exploring the application of his theories in interdisciplinary fields by putting together a conference on the economics of Alzheimer’s disease with his wife Tonya, a neuroscientist specializing in Alzheimer’s at UC Santa Barbara. Kydland has always emphasized the importance of sharing workspace with fellow academics in a wide range of fields. In very practical terms, the outcome of this cross-pollination could bring us closer to answering some of the world’s most pressing questions, including developing new ways of treating Alzheimer’s.

What’s the future of Europe?

Some of these questions are inherently economical, of course. The future of Europe, for example. And how the European Union’s economies can grow again at sustainable rates. "There are deep-seated problems in those nations," Kydland emphasizes. "And they need to focus on how they can get productivity curves to turn back up."

"I’ve always been motivated by what I regarded as interesting questions", Kydland admits. And he’s known as a person who is "curious about questions in economics and encourages young people to do independent research," says Carlos Carriga, a colleague from the Federal Reserve Bank of St. Louis. If his students and collaborators take a moment and think, ‘Is what I’m spending my time on important?’ Kydland feels satisfied.

A piece of advice (sort of)

Even though, according to Kydland, Norwegians don’t usually feel comfortable giving advice to the young, he does have a pearl of wisdom to offer: he suggests that his graduate students don’t read too much, because this might take their thinking in the direction of academic literature, and divert them from their own path. Kydland adds with a knowing smile, "If you come up with something that everyone thinks is wrong but you’re completely convinced it’s correct, then it could be a big deal,"

A night on the town with a Nobel laureate

While economics remains Kydland’s major interest, throughout his life he’s accumulated a wide range of other passions, hobbies and activities, such as: playing the guitar, running a mink-farm and running marathons. He still has one particular notebook from the lectures he attended at Carnegie Mellon. The pages are filled with firmly penned down formulae, theorems, proofs and side notes: these are the notes from the class in macroeconomics taught by Bob Lucas, and the mathematical proof is the cornerstone of Lucas’s Nobel Prize winning work.

Blues is another such passion. Going to a pub in downtown Santa Barbara with Kydland and his friends is a truly remarkable night out. Not only is Kydland at home here, as the greetings from bartenders and staff suggest, but he’s also very familiar with the band and its music. It doesn’t seem to matter in that moment what Kydland does with the rest of his time, what kind of ground-breaking work he’s done and will continue to do: it’s simply an exchange of energy between the artists and their fan. As his colleague at UC Santa Barbara Douglas Steigerwald notes,

He much prefers to be known as somebody who supports blues music, not as a famous economist.

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So, what does Kydland's work mean for us?

"Until the 1970s, the assumption was that people in the economy – unions, businesses, households – don’t think ahead. If they learn at all, they do so by gradually adjusting to the past rather than reasoning about the future. Kydland changed that."

Tim Harford
Financial Times columnist and author of
The Undercover Economist

"Kydland’s work on changing expectations over time, and the implications of that, speaks directly to financial market investors craving insight."

Paul Donovan
Global Chief Economist
UBS Wealth Management

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