1. Their Contributions

The Old Keynesian macroeconomic models were built on statistical relationships between aggregates such as production, consumption, inflation and unemployment. The Nobel committee, however, argues that this reliance on statistical relationships was the actual bottleneck, which caused these models to fail in the 1970s oil crises, when policy produced rising inflation without bringing unemployment down as expected (Royal Swedish Academy of Sciences, 2026).

This is where the Lucas critique comes into play. The idea is simple. If policymakers try using these statistical correlations by aiming for lower unemployment and causing higher inflation through lower interest rates, people adjust their expectations and start acting accordingly (Smith, 2026). Workers start bargaining for the expected, higher inflation and real wages adjust, causing unemployment to revert to its original level with adjusted expectations.

This is exactly why Smith (2026) argues that the macroeconomy needed foundations that do not shift when a policy comes into play. These include technology, preferences and the mechanism behind expectations. These kinds of models already existed as neoclassical models such as the RCK (Ramsey–Cass–Koopmans) model, but with a perfect-foresight assumption. This assumption resulted in a single, optimal time-path for the consumption decisions of households, given the known information, leaving no room for unexpected events.

In the real world, however, an unexpected rise in productivity may occur, causing households to adjust their consumption path immediately. When Hall published his paper on consumption in 1978, he showed that already known information such as lagged income had no explanatory power over changes in consumption, with one exception: stock prices (Hall, 1978, as cited in Smith, 2026).

Despite this exception, he persuaded economists that the rational-expectations approach under uncertainty was the one to follow (Smith, 2026). Smith (2026) underlines an important policy implication regarding Hall’s work: if people plan ahead, policymakers can shape behaviour today by shaping expectations with promises, provided that people understand these promises.

There was still a problem. The models at that time suggested that central banks should have no effect on real variables such as unemployment and output, but rather only change prices. Then, nominal prices would adjust and real variables would return to where they started.

But in reality, when the Fed raised rates to fight inflation in the early 1980s, a recession followed (Smith, 2026). So there had to be a gap between the theory and how central banks actually worked.

Friedman’s theory suggested that central banks affect inflation by controlling the money supply, but central banks do not target a specific money supply; they set interest rates and supply money to keep that target rate (Cochrane, 2026). But why?

In the 1980s, with new financial products being introduced, money demand started to become more unpredictable. Therefore, fixing the money supply would result in a market-determined interest rate, and with unpredictable demand, a shortage of money would cause a jump in interest rates and hurt the economy. If central banks decide on the interest rate instead, by supplying more money they can absorb such shocks. This does not put more pressure on inflation either, since these demand shocks mostly come from financial products and people hold the extra money rather than spend it; hence no further pressure on prices is created.

Here comes Woodford’s contribution. He built a model to explain the relationship between inflation and the central bank, using Hall’s households (Smith, 2026). Consider the first gap: why do central banks create a real difference and not just nominal price changes? Woodford uses Calvo pricing, a form of sticky prices (Smith, 2026). Because firms cannot adjust prices immediately in response to a policy, this friction causes real economic measures to change in the short term when prices fail to adjust. As for the second gap: how can a central bank that sets interest rates still control inflation? Woodford suggests that central banks (CBs) follow a rule: if inflation rises by x%, increase the interest rate by (x + delta)%, causing the real interest rate to rise and slowing down the economy (Cochrane, 2026).

2. Their Broader Significance

So, how did these developments aid policymakers? The old Keynesian models acted like a recipe book written based on past data, looking for correlations and suggesting X to achieve a higher Y, because in the past X ended up that way. This has two caveats. First, a policy that has never been applied cannot be evaluated, since it lacks data. Second, as the Lucas critique argued, expectations react to policy changes. A model with microfoundations is built on people’s decisions, preferences, the technology available and their expectations (Royal Swedish Academy of Sciences, 2026). Those mechanisms keep working when policy changes, and even help us understand the newly formed expectations and their potential results under the new policy. This allows us to use the model even if the policy is new and there is no data to show a potential correlation with economic metrics.

In addition, as Smith (2026) has already suggested, expectations themselves become a potential policy tool, provided that households understand and believe the implications. This helps central banks grasp how important their credibility is. For instance, in Türkiye after 2021, the CBRT lost its credibility and official inflation statistics were widely questioned (Al Jazeera, 2022; Kara, 2023), resulting in a tougher and longer disinflation policy, as it failed to affect and adjust households’ expectations effectively (International Monetary Fund, 2024, 2026).

Hall and Mishkin (1982, as cited in Cherrier, 2026) also showed that not all consumers are forward-looking. They even gave a rough split: 80/20. Roughly 20 percent of households are hand-to-mouth and cannot act on their expectations because they have no savings and they cannot borrow. Hence, they consume their current income. This rough split also implies that central banks reach the two consumer types through different channels. Eighty percent of consumers respond to central banks’ announcements about the future, and expectations can be used as a policy tool on these consumers, but the remaining 20 percent respond only to changes in their current real income.

3. My Assessment

In my assessment, the most consequential work of Hall and Woodford for policymakers is the introduction of expectations as a policymaking tool and the strengthened importance of credibility, and therefore of central bank independence (International Monetary Fund, 2024). The previously mentioned Türkiye example provides a real-world case to see what would happen if these suggestions were to be ignored. With these new insights Hall and Woodford provide, we can now see the potential cost of losing credibility, or of trying to exploit a statistical correlation in past data. The Türkiye example also provides a counterexample to Cochrane’s (2026) objection to praising central-bank stabilisation right after inflation reached about 10% in the US, Europe and the UK. When credibility is lost, even the 10% inflation rate that most of the Western world fears becomes desirable and, worse, unreachable (International Monetary Fund, 2026). Smith’s (2026) argument that the 2022–23 disinflation did not trigger a big rise in unemployment is another potential example of the expectations channel working, even though this reading is debated.

In the early 1980s, when the Fed raised interest rates to fight high inflation expectations and caused a recession (Smith, 2026), that recession was the price Volcker paid to restore credibility. This illustrates Cherrier’s (2026) argument: practice comes first and theory follows it. So, did Hall and Woodford really aid policymakers, or did they explain an already present phenomenon? I agree with Cherrier’s observation: generally, practice comes first, as the real problem occurs in the real world first and needs an urgent solution; then comes the theory. But this does not mean that theory is meaningless; it helps the practice to be generalized and builds foundations so that we understand the actual mechanics of the solution. We can then engineer it for various other problems, or maybe even better, spot a potential problem beforehand and prevent it. The 2008 crisis is a good example of this: when interest rates hit zero, there was no prior experience to show central banks the way, so Woodford’s work pointed the way. Central banks used expectations as a tool, promising to keep rates low for a long time to induce consumption today (Smith, 2026). Hence, theory guided practice right after following it. Therefore, I believe that Hall and Woodford’s work supports policymakers in their decision-making, and with its support there is potential that fewer people will get hurt because of suboptimal decisions by policymakers.

References

Al Jazeera. (2022, January 7). Just how bad is inflation in Turkey? It depends on who you ask. https://www.aljazeera.com/economy/2022/1/7/just-how-bad-is-inflation-in-turkey-it-depends-on-who-you-ask

Cherrier, B. (2026, October 12). On the microeconomic foundations of macroeconomic stabilisation: The Hall–Woodford prize in historical perspective. The History of Economics Dispatch. https://theundercoverhistorian.substack.com/p/on-the-microeconomic-foundations

Cochrane, J. H. (2026, October 12). A great Nobel. The Grumpy Economist. https://www.grumpy-economist.com/p/a-great-nobel

International Monetary Fund. (2024, October 11). IMF Executive Board concludes 2024 Article IV consultation with Türkiye (Press Release No. 24/369). https://www.imf.org/en/news/articles/2024/10/11/pr-24369-turkiye-imf-executive-board-concludes-2024-aiv-consultation

International Monetary Fund. (2026). Republic of Türkiye: 2025 Article IV consultation (IMF Country Report No. 26/43). https://www.imf.org/-/media/files/publications/cr/2026/english/1turea2026001-source-pdf.pdf

Kara, H. (2023, July 3). Turkey still has a long road back to financial normalcy. Nikkei Asia. https://asia.nikkei.com/Opinion/Turkey-still-has-a-long-road-back-to-financial-normalcy

Royal Swedish Academy of Sciences. (2026, October 12). Press release: The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel 2026. NobelPrize.org. https://www.nobelprize.org/prizes/economic-sciences/2026/press-release/

Smith, N. (2026, October 13). A Nobel for New Keynesian macro, at last! Noahpinion. https://www.noahpinion.blog/p/a-nobel-for-new-keynesian-macro-at