This article first appeared in the Planet Money newsletter.You can sign up here.On Monday morning, the world's econ nerds tuned in to an announcement from Sweden to learn who won this year's Nobel Prize in economics.
And we got a lesson involving … ice cream.The winners were Robert Hall of Stanford University and Michael Woodford of Columbia University.The prize committee honored them "for microeconomic foundations of macroeconomic stabilization."To explain what the heck that means — as we will try to do in this newsletter — Timo Boppart, an economist at Stockholm University and member of the prize committee, stood up and walked around like he was giving a TED Talk.
At one point, he brought up an image on the screen behind him: an ice cream menu.Boppart used the ice cream menu to serve up a sweet lesson in economics."How do firms actually set prices?" Boppart asked." This is illustrated here with this ice cream menu.
Prices do not adjust [on] a continuous basis.Firms instead set the price of this ice cream for a whole season."Ice cream was a poetic example.
Because prices, like ice cream, can get sticky.In fact, economists use the term "sticky prices" to describe how prices can stubbornly stay put even as economic conditions change.That seemingly minor detail can have huge consequences for the entire economy.
Sticky prices are a cornerstone of what's known as "New Keynesian economics" — a framework that has helped reshape macroeconomic theory and how policymakers think about fighting recessions and controlling inflation.This year's prize honored work that helped lay the foundations for New Keynesian economics.In the process, Hall, Woodford, and other scholars helped breathe new life into the ideas of economics giant John Maynard Keynes, whose intellectual legacy, for a time, seemed in danger of melting away.To understand why, we need to go back to the 1970s, when the economy experienced something that, for some, seemed to invalidate Keynesian economi...