Thomas J. Sargent

Tom Sargent was, alongside Nobel Laureate Robert Lucas, a leading figure of the rational expectations revolution in the 1970s. Testing rational expectations against real world data, they demonstrated how the policies of fiscal and monetary institutions will not, in the long run, influence output or unemployment. Today, Sargent remains not only one of the most cited economists but ranks among the most popular professors with students. Though he has a successful academic career to look back on, he is still eager to learn new things, computer languages, for example.

The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel (shared), 2011

In the snowy mountains of Montana, 320 miles from Salt Lake City, lies the little town of West Yellowstone with a population of just over 1,000 people. During the summer months, it’s full of tourists visiting the national park of the same name. At this time of year, with all the wooden houses covered in snow, it feels like the quietest place in the whole world.

Sargent wears snow boots with a suit and red tie for the occasion. He explains how much he enjoys his condo outside of town, the nature and especially fly fishing, a popular sport in the area (and the reason fellow Nobel Laureate Angus Deaton often visits too).

It’s an unlikely location to interview a Nobel economist, quite different from cluttered offices, but it is the perfect place to tell a good story - which is exactly what Sargent is about to do.

The foundation of economics, explained by a physicist

The Nobel Laureate of 2011 likes to use examples from the past to illustrate his point. When asked about his Nobel work, he mentions the great physicist Richard Feynman and explains why economics is like a game of chess before taking us back to the 16th century. “It’s a beautiful analogy,” Sargent begins, referring to Nicolaus Copernicus and later Johannes Kepler who were working on the laws of planetary motion at a time when people still believed that the earth was the center of the universe. Sargent explains how Kepler put his many observations into mathematical equations. “It was pattern recognition,” he says. It’s similar to the work of an economist today who work with huge amounts of data in order to select patterns. “You’re very agnostic and don’t try to have a prejudice at that point. Much of one.”

But the most challenging task is to turn a non-causal model into a causal one. For astrophysics, it took 60 years before Isaac Newton used Kepler’s work as a basis and established a causal model. “That’s the gold standard,” Sargent says. “You can teach a machine to do what Kepler did. But you need something else to do what Newton did.”

It’s quite similar to what Sargent and his co-workers did when they developed a method for interpreting patterns. Their work was not concerned with planetary motion but with fiscal and monetary authorities and their influence on economic variables such as GDP, inflation, employment and investment. Sargent established methods to analyze causal relationships concentrating not on the effect of unexpected events, as his co-laureate Christopher Sims was, but on temporary and long-term policy changes.

What’s the real impact of monetary and fiscal policy?

Sargent emphasizes the legitimate power the government has in certain areas including taxation and social security systems. How much money does the government take in and from whom? How does it spend money and for what? “If you’re like the United States now, we spend more than we tax,” he says. “And it’s going to get worse.”

“Fiscal policy has a huge ability to affect an economy but the central bank is a sideshow,” he says. “This is not what you hear in the news, but to a first approximation, it’s a place to start. In the long run, it can affect the price level under certain circumstances but it can only have temporary effects on interest rates.”

Citing the famous Milton Friedman, Sargent argues that expansionary policies of monetary authorities can’t affect unemployment. “This is largely decided elsewhere,” he explains and mentions the work of his colleagues Peter Diamond and Christopher Pissarides, both Nobel Laureates awarded for their theories on matchmaking in labor markets. “If you ask what determines whether you have a job or not, the central bank would be way down the list. All it can do is open market operations. Its assets are government bonds and its liabilities are money.”

The economist acknowledges that the strict separation between fiscal and monetary policy is a theoretical one, as he cites when it broke down like the German hyperinflation of the early 1920s or the current crisis in Venezuela. “They’re taxing people who are trusting the government holding its currency,” he says.

When transfer systems trap

Sargent has also been studying unemployment outcomes in both the US and Europe. He focused on the design of welfare systems and the duration of unemployment compensation programs. Within this area, he examined the depreciation of human capital as a consequence of long-term unemployment.

“Welfare programs can trap you into having it in your own best interest to stay on government benefits,” he says. It’s similar to what he said when addressing the audience at the Nobel banquet in Stockholm in 2011. “People respond to incentives, including the people you want to help.”

Replacement rates and duration of payments are the crucial factors of compensation programs. Sargent illustrates how many European countries, after World War II, gradually decided to set up systems in which a huge percentage of the last wage was paid, for an infinite amount of time.

Those systems were doomed to break down with the rise of globalization and increasing competition from abroad. “If your unemployment compensation is linked to your last wage and now you have skills that are much less valuable, you get offers for wages less than your compensation,” he says. “Why would you agree to that? You’re in a trap. And your skills will deteriorate further.”

He points out that there are various ways governments could use their money more wisely when it comes to compensation systems. For example, instead of giving a flat rate and then cutting people off, they could set an amount that depends on how long someone has been unemployed for. “It turns out that gives you the incentive to look hard early,” he says.

Since there remain a lot of people who were once high skilled but have become “wards of the state” due to technological developments, Sargent also emphasizes the importance of retraining programs, whether it’s outside or inside the job.

Staying adaptable, at every age

While it’s hard to predict which ways technologies will go, Sargent feels that it’s extremely important to stay flexible and keep learning, even as you age. To him, the key ingredient is to be interested and enthusiastic. He explains that he was very good at using what is now an old obsolete computer, and that he was a specialist on economic models no one is referring to anymore. But it doesn’t bother him. Despite his age, he has learned some new computer languages fairly recently to keep himself feeling agile.

Today, he’s spending some of his time in Shenzhen and Beijing, examining new ways to use statistics to learn more about the Chinese economy. It’s fun for him to be in China. “They’re very eager to exploit technological developments,” he says. “They train a lot of engineers and scientists and they’re very ambitious.” His continued motivation makes him living proof of the value behind his argument.

Though Sargent clearly believes that everyone has their own part in having a chance to succeed, he also sees policy reforms as highly important. In the past, he has used computer models to tackle labor market problems. In his mind, there are two harmful features, especially to young people, job protection and minimum wages.

Why do young Europeans struggle when entering the job market?

When talking to Sargent, you get the impression that he must be a wonderful teacher. He is good at explaining without overcomplicating things, he makes a joke from time to time, and he has a calm and comforting way of talking. At one point, he tell us how he dreamed of starting his own high school, one that would be very different from other institutions.

“They make students work way too much,” he says. “If I were in their shoes, it would destroy my interest in anything. You’re supposed to be having fun. I’m not talking about having fun doing drugs or drinking.” He laughs.