The Nobel Prize in economics for 2026 was awarded to Robert E. Hall and Michael Woodford. According to the Nobel committee, the laureates had developed macroeconomic models that significantly improved our ability to implement effective stabilization policies. The committee is of the view that, on the basis of these models, well-timed fiscal and monetary policy measures can reduce the economy’s peaks and troughs.
The models developed by the laureates are based on the ideas of English economist John Maynard Keynes. In the Keynesian framework, the output that an economy can generate with a given pool of resources (i.e., labor, tools, and machinery) and a given amount of technology, without causing inflation, is called potential output. However, if—for whatever reasons—demand for the produced goods is not strong enough, this leads to an economic slump. Inadequate demand for goods leads to only a partial use of existent labor and capital goods. According to this view, it is then the role of the government and the central bank to close the gap between potential output and the actual output. Keynes suggested that peaks and troughs can be evened out by stimulating demand (accelerating) when it is too low and slowing it (braking) when it is too high.
Boom-Bust Cycles and the Central Bank
For the Nobel laureates, similarly to Keynes, boom-bust economic cycles are about the strength of the economy. However, rather than looking at the gap between potential and actual output, the Nobel laureates have utilized the real business cycle model (RBC) to explain boom-bust cycles. On this view, a major cause behind economic boom-bust cycles is technological shocks. A positive technology shock implies that, with a given supply of capital and labor, the economy could generate more output. A recession is caused by a negative technology shock that leads to a fall in output (i.e., to an economic bust).
Following Mises and Rothbard, contrary to the Nobel laureates, an economic boom is not about an economic prosperity and wealth generation, but about the diversion of resources from the wealth-generating activities towards activities that consume and do not produce wealth (i.e., undermine the wealth-generating process). If for some reason the diversion of resources is arrested, various non-productive activities that sprang up as a result of this diversion come under pressure (i.e., an economic bust emerges). Therefore, what is required in order to establish how boom-bust cycles are formed is to identify the cause that gives rise to the diversion of resources from wealth-generators to non-wealth-generators.
Central Bank Policies: The Key Factor Behind Boom-Bust Cycles
In a free, unhampered market, the economy would be subject to various shocks but it is difficult to envisage a phenomenon of regular boom-bust cycles. According to Rothbard,
Before the Industrial Revolution in approximately the late 18th century, there were no regularly recurring booms and depressions. There would be a sudden economic crisis whenever some king made war or confiscated the property of his subjects; but there was no sign of the peculiarly modern phenomena of general and fairly regular swings in business fortunes, of expansions and contractions.
The boom-bust cycle phenomenon is somehow linked to the modern world. Careful examination would reveal that the link is the modern banking system, which is coordinated by the central bank.
Whenever the central bank adopts an expansionary monetary stance, it sets in motion exchanges of nothing for something as a result of the newly-inflated money and credit. It is this that sets the diversion of wealth from wealth-producers to the holders of the newly-generated money. The emergence of activities on the back of the central bank’s expansionary monetary policy gives rise to a false economic prosperity—an economic boom. The expansionary monetary stance ultimately results in the economic impoverishment of wealth producers.
Once the central bank tightens its monetary stance—which must inevitably happen at some point—the artificial boom is stopped abruptly. This leads to the demise or severe curtailment of such activities—an economic bust. The heart of business cycles is the inflationary process which entails the diversion of resources from wealth-generating activities towards non-wealth-generating activities. This process is set by the monetary policies of the central bank.
The idea of employing a model in order to establish policies to stabilize the economy is counterproductive. A policy of tampering with the economy leads to a weakening in the wealth-generation process and generates economic impoverishment. Stabilization policies prescribed by such macro models are just another form of tampering with the economy.
The Importance of the Private Saving, a Subsistence Fund, and Capital Investment
What drives economic growth is not only the existing stock of capital goods and the pool of labor, but also the subsistence fund that maintains individuals engaged in various stages of the structure of production. On this, Richard von Strigl wrote:
Let us assume that in some country production must be completely rebuilt. The only factors of production available to the population besides laborers are those factors of production provided by nature. Now, if production is to be carried out by a roundabout method, let us assume of one year’s duration, then it is self-evident that production can only begin if, in addition to these originary factors of production, a subsistence fund is available to the population which will secure their nourishment and any other needs for a period of one year. . . . The greater this fund, the longer is the roundabout factor of production that can be undertaken, and the greater the output will be.
Market production and an expanding subsistence fund—through genuine, private saving—ironically supports both government activities and activities that arose due to expansionary monetary policy. Alongside this artificial growth, there can still be genuine positive growth and production.
If, however, production, saving, the subsistence fund, and capital investment begin to decline and/or credit contracts, then—regardless of any increase in government spending and inflation by the central bank—overall economic activity cannot be revived. Expansionary fiscal and monetary policies do not rescue the economy, they rescue activities that the economy cannot afford. Such policies sustain waste and promote inefficiency, draining resources from growth and efficiency.
Allowing the Market to Do the Allocation
According to Keynesian thinking, one cannot trust a market economy, which is seen as inherently unstable. Hence, there is always the need for governments and central banks to manage the economy. However, allowing the market to do the allocation of resources leads to better results. Even the founder of the Soviet Union, Vladimir Lenin, understood this when he introduced the market mechanism for a brief period in March 1921 to restore the supply of goods and prevent the economic catastrophe.
The best economic policy for the central bank and the government is to do nothing as soon as possible. By doing nothing to intervene in the free market economy, the government and the central bank will enable wealth-generators to accumulate savings, thus strengthening the subsistence fund and capital investment. This will ultimately raise living standards.
Conclusion
Robert E. Hall and Michael Woodford may have won the Nobel Prize for macroeconomic models that have improved the ability of the government and central bank to manipulate the economy, however, this is hardly a positive. In fact, instead of implementing stabilization, such policies—and the Keynesian presuppositions underneath them—undermine economic stabilization. These Nobel laureates have ignored the key factor that sets boom-bust cycles—the central bank’s monetary policies. To eliminate the business cycle menace the central bank must stop tampering with the economy, or, better yet, cease to exist.
