Finn Kydland and Edward Prescott
Citation: For their contributions to dynamic macroeconomics: the time consistency of economic policy and the driving forces behind business cycles.
The key idea
Time inconsistency: optimal policy announced today becomes sub-optimal tomorrow once private agents have reacted. Real Business Cycle theory: business cycles can arise purely from technology shocks under flexible prices.
The explanation
Kydland-Prescott's 1977 paper showed that discretionary monetary policy is dominated by rules-based policy precisely because of the credibility problem. Their 1982 paper launched RBC theory: business cycles as the optimal response of forward-looking agents to technology shocks. The methodology (calibration, computational dynamic stochastic general equilibrium) reshaped macroeconomics.
Why Africa should care
Time inconsistency is the textbook diagnosis of African inflation cycles: central banks promise low inflation, then accommodate fiscal pressure, then surprise. Inflation-targeting frameworks (Kenya 2012, South Africa 2000, Ghana 2007) are explicit responses to the Kydland-Prescott problem. RBC's calibration methodology is used by Africa-focused DSGE models at the IMF, the AfDB, and the SARB.
How to use it
When a government promises future policy, ask: what makes today's promise credible? If nothing — no constitutional rule, no independent agency, no political cost to reneging — discount the promise. Time inconsistency is the lens.
Canonical works
- Finn E. Kydland and Edward C. Prescott (1977) "Rules Rather than Discretion: The Inconsistency of Optimal Plans" Journal of Political Economy
- Finn E. Kydland and Edward C. Prescott (1982) "Time to Build and Aggregate Fluctuations" Econometrica
More from Behavioural, empirical, institutional · 2000-2009
- 2000James Heckman and Daniel McFadden
Heckman: selection bias has structure and can be corrected. McFadden: the multinomial logit and conditional logit make discrete-choice data (yes/no, which-brand) econometrically tractable.
- 2001George Akerlof, Michael Spence, and Joseph Stiglitz
Akerlof: in markets with information asymmetry, bad goods drive out good ones (the lemons problem). Spence: education can signal innate ability even if it produces nothing. Stiglitz: insurance markets unravel under asymmetric information; screening contracts emerge in equilibrium.
- 2002Daniel Kahneman and Vernon Smith
Kahneman: prospect theory — people are loss-averse, weight probabilities non-linearly, frame matters. Smith: experimental markets reach competitive equilibrium remarkably fast even with few traders.
- 2003Robert Engle and Clive Granger
Engle: ARCH/GARCH models — volatility clusters, time-varies, can be forecast. Granger: cointegration — non-stationary series can share a stationary long-run relationship; pairs trading and error-correction modelling follow.
- 2005Robert Aumann and Thomas Schelling
Aumann: repeated games support cooperation via the Folk Theorem; common knowledge is more subtle than it seems. Schelling: focal points solve coordination problems; tipping models explain segregation; deterrence requires credible commitment.