Thomas J. Sargent: A Dynamic Economist
Story by John Miller
On March 20, nine portraits adorned the wall of the Nobel Laureate Gallery in the Tepper School of Business. The next day, Thomas J. Sargent joined his fellow economists, colleagues, and peers as the tenth portrait in the gallery.
Sargent, a former Research Affiliate at the Tepper School, shared the 2011 Nobel Memorial Prize in Economic Sciences with Christopher A. Sims “for their empirical research on cause and effect in the macroeconomy.” This work on rational expectations showed that individuals anticipate economic conditions when making decisions, meaning certain government policies have little impact on spending, saving, or pricing.
During his keynote address at the Tepper School’s 75th Anniversary Academic Symposium, Sargent highlighted the deep personal and professional connections he shared with his colleagues, stating, “I personally knew all the people who are on that wall, those portraits, so I’m going to tell you … I am a product of having known them.”
Sargent elaborated on his relationships with the other Nobel laureates, revealing how their collective work contributed to the growth and application of economics, its implications for social questions, and its influence on decision-making.
An edited transcript of selections from Sargent’s speech is below, in the gray boxes. Annotations from other Nobel laureates and colleagues, in white boxes, highlighting their connections and contributions to each other, the Tepper School, and field of economics.
Thomas J. Sargent
I feel lucky that I was here when I was 23 … I am thinking about some of the graduate students here. They’re 23. And when they’re standing up here when they’re my age, it’s going to be amazing.
Tom Sargent, Keynote Address at the 75th Tepper School Anniversary Academic Symposium
HERBERT A. SIMON
Tom Sargent on Herbert A. Simon
I think he’s one of the founders of behavioral economics.
He distrusted maximizing models and statistics. He wrote about bounded rationality. Oh, and he had strong opinions … I authored a book called Bounded Rationality in Macroeconomics and got a letter from Simon saying, “You’re out of your mind!” What did I do? I replaced the agents in the Lucas-type model with a model he didn’t know as much, with agents he didn’t know as much, and I had to use statistics. And he said, “That’s not what I meant by bounded rationality.” That was fun.
“In the past few years, it has become quite acceptable (some would even say ‘fashionable’) in economics to challenge the heroic portrait of human rationality that is displayed by the theory of maximization of expected utility. One erstwhile devotee (and coinventor) of rational expectations, Thomas Sargent, has even titled a recent book Bounded Rationality.”
FRANCO MODIGLIANI
Tom Sargent on Franco Modigliani
Modigliani is one of the founders of modern macroeconomics.
Although macroeconomics was invented by John Maynard Keynes, Modigliani tried to make sense of Keynes. He had concepts that would map the loose words in Keynes’s work into a set of mathematics.
He was very big into micro foundations for macro models; he lived by it. Micro foundations for the demand for money, for the difficult statistical relations that are revealed by statistics, and the failures of the Keynesian consumption function. He wrote a lifecycle model with students here that was revolutionary. And, if you want to think about demographics and their effect on growth and interest rates, that’s Modigliani, still to this day.
Herbert Simon on Franco Modigliani ” … ask Franco how scheduling lines of paint cans in a factory fit into the life and career of a Nobel-winning economist. He will probably get angry if you ask him that.”
Herbert A. Simon in “Three Nobel Careers,” GSIA Magazine, 1992.
Franco Modigliani on Herbert Simon “Ask Herb Simon how he managed to keep from being contaminated by all his involvement with economists.”
Franco Modigliani in “Three Nobel Careers,” GSIA Magazine, 1992.
“The people who were then at Carnegie included Cyert, March, Simon, and Modigliani … It was quite an impressive group … The Carnegie experience was extraordinary. I really so enjoyed it … it was such an interesting place to be. Interdisciplinary work was going on, and the people I was taking courses with encouraged students to be enterprising in their own work.”
Oliver Williamson, interview with Richard Swedberg, June 7, 1988.
“But the most glaring flaw of [macroeconomic rational expectation hypothesis] is its inconsistency with the evidence: if it were valid, deviations of unemployment from the natural rate would be small and transitory—in which case [Keynes’s] The General Theory would not have been written and neither would this paper. Sargent has attempted to remedy this fatal flaw by hypothesizing that the persistent and large fluctuations in unemployment reflect merely corresponding swings in the natural rate itself.”
Franco Modigliani, 1995. “The Monetarist Controversy, or, Should We Forsake Stabilization Policies?”
MERTON MILLER
Tom Sargent on Merton Miller
Merton Miller wrote a famous paper with Modigliani. He had been teaching MBAs, and in those days, it was about, “What’s a big problem for a firm? How should it finance itself? Should it issue debt or equity? If it issues debt or equity, what kind?” All sorts of books said it should depend on stuff and circumstances, but as it turned out, it’s irrelevant.
The Modigliani-Miller theorem said, “Don’t worry about it.”
Debt or equity, it doesn’t matter. It’s because of some competition, considering those who are buying your debt or equity, and what they can do.
From the first day, I was able to talk to Franco [Modigliani]. At Carnegie, there was no great gap between the senior and junior faculty. We were a community of scholars.
Merton Miller in “Three Nobel Careers,” GSIA Magazine, 1992.
“‘As our discussions evolved, we decided that maybe we should write some of it down … We wrote our first paper in 1958. The collaboration, for the time, was very unusual but very Carnegie.’ The 1958 paper defined the project and research agenda for the “M&M Theorems.” Nicknamed for Modigliani and Miller, the theorems state that the way a corporation finances its operations – whether through bonds that increase its debt or through stocks that disperse its ownership – is irrelevant to investors. What matters is the profitability of those operations.”
ROBERT E. LUCAS
Tom Sargent on Robert E. Lucas
I’m going to talk about Lucas and Prescott as a pair. One had the gift of language, Lucas, and Prescott, well, he’s basically inarticulate. But those two guys could talk to each other.
“Beginning in 1971, [Robert] Lucas and Tom Sargent … brought the theory of rational expectations into national and international prominence. It is not without irony that bounded rationality and rational expectations, two of the major proposals after Keynes for the revision of economic theory (game theory is a third), though entirely antithetical to each other, were engendered and flourished at the same small business school at almost the same time.”
EDWARD C. PRESCOTT
Tom Sargent on Edward C. Prescott
Prescott was a graduate student here. He knew Markov chains, and he knew dynamic programming. Lucas was doing some deterministic continuous-time control.
Together, they [Lucas and Prescott] created applications of dynamic programming in macroeconomics.
“Every day about 3:30 PM, Bob Lucas and Leonard Rapping headed to the lounge to drink coffee and discuss economics with passion and intensity. I listened. Bob and Leonard were in the process of creating their model about the aggregate labor supply that featured intertemporal substitution and adaptive expectations.”
FINN KYDLAND
Tom Sargent on Finn Kydland
In the tradition of Modigliani, Kydland built one of the most beautiful modern models of the man for money.
Finn Kydland is a student of Prescott. He reworked optimal taxation problems or optimal monetary policy problems in a rational expectations model.
Kydland, who knew dynamic programming, looked at the problem and immediately said it does not fit dynamic programming. It’s not recursive. It’s like the simultaneity goes both ways. It’s a so-called non-serial problem. On the basis of that, he wrote one of the first two papers about time inconsistency.
Four years later, Kydland came back to write a 1980 paper with Prescott. What they showed, they invented something, I call it dynamic programming squared. They showed how to, if you used the planners, Bellman equation had as a state variable, the value function from another Bellman equation.
“Whether forecasts are rational is still open to debate. In Sargent the rational-expectations hypothesis is tested and accepted. He also explains why many other tests that rejected the hypothesis are invalid.”
“I work in a macroeconomic tradition developed by John Muth, Robert E. Lucas, Jr., Edward C. Prescott, Finn Kydland, Nancy Stokey, and Neil Wallace.”
OLIVER WILLIAMSON
Tom Sargent on Oliver Williamson
The next person is the reason I ever got to Carnegie [Mellon], my benefactor, Oliver Williamson. I was his RA (research affiliate).
He was about the theory of the firm. He thought hard about what a firm is and what a market is.
What’s a market? Well, first thing, it involves prices that are somehow set. You let people trade at them. The competitive equilibrium. So, you have prices and you decentralize. Or you have a command economy.
“The Objective of the present paper is to develop a model of the firm which is both behavioral and analytical … The primary tool used for developing the implications of the model is maximization (minimization) analysis.”
Oliver Williamson, “A Behavioral Model of the Firm,” August 1961.
“Everyone knows that Herb [Simon] had strong views about how social science research ought to be done and that he had grave reservations about the neoclassical economics research agenda … As a Graduate student in Herb’s class on Mathematical Social Science in the spring of 1962, I had the occasion to test that.” (Williamson proposed a paper, “Selling Expense as a Barrier to Entry.”) “To my enormous relief [Simon’s] reply was ‘Anything that advances our understanding of complex phenomena is valued.’ My recollection is that Herb gave me a good grade on the paper … “
Oliver Williamson, “A Tribute To Herbert A. Simon,” March 19, 2001.
DALE MORTENSEN
Tom Sargent on Dale Mortensen
Dale Mortensen was a student here, and you can tell.
The Arrow-Debreu model is the standard macro model that Lucas, Prescott, and Kydland have, and it’s a model Lucas stuck to. He thought it was the best model. There’s labor supply and labor demand, and they intersect. The market clears every day. There are no jobs. There are homogeneous types of labor…there are no enduring relationships in that model. Mortensen said, “Well, there are.” So, there’s something wrong with the model, and he built a model with the jobs. And now there are vacancies in unemployment. So, he talked about a way to do that. This remains today a leading model.
“The paper by Mortensen also seeks an efficient labor contract. Mortensen determines the arrangement and intensities of search that maximize the expected product of the match between worker and job when search for new matches is uncertain and costly.”
Edward C. Prescott, “Introduction to Festschrift for Herbert A. Simon, June 1977.
“Edward Prescott and Dale Mortensen had just graduated from Carnegie. The junior faculty told admiring stories about both of them and their works.”
LARS PETER HANSEN
Tom Sargent on Lars Peter Hansen
If a graduate student … comes in and they say, “I have a great stochastic discount factor,” the first thing you say is, “Show me it’s inside the Hansen-Jagannathan bounds.
[Robert] Lucas wrote a paper saying everything the way we were doing econometrics before was wrong because it didn’t build in rational expectations. And he said someone should figure that out, but it’s hard. Lars basically figured it out, leading to a pair of papers that year.
One was doing it with a complete model. There are two, Hansen-Singleton. [Hansen] did something very clever. Maybe I can find an M that will make it work, without telling you what the M is. After all, the stochastic discount factor is just a random variable. So, what he did was to reverse engineer a class of stochastic discount factors that would satisfy that equation. As it turns out, it’s a class, a set of random variables. This is the birth of the Hansen-Jagannathan bounds.
“As a graduate student at the University of Minnesota, I had the opportunity to take classes from Chris Sims and Tom Sargent. Both emphasized the idea that dynamic econometric models should be viewed as restrictions on stochastic processes.”