January 2017 newsletter – 2016 Prizewinners

The 2016 ‘Nobel Prize’ in economics

The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel 2016 was awarded jointly to Oliver Hart (Harvard) and Bengt Holmström (MIT) for their contributions to contract theory.

Contracts are central to economic activity, and to life more broadly. However, in many activities it is far from easy to draw up a contract which delivers the best result. The probalems are well-known: incomplete information, moral hazard, measurement of oucomes, incentives, conflicts of interest and more. Practical applications range from the design of managers’contracts to the rights of investors in bankrupt financial firms. Contract theory enables us to think clearly about the issues involved in dealing with these problems. In the view of the prize committee ‘the contributions of this year’s laureates, Oliver Hart and Bengt Holmström, are invaluable in helping us understand real-life contracts and institutions, as well as the potential pitfalls when designing new contracts’.

For example, Holmström demonstrated how a principal (e.g., a company’s shareholders) should design an optimal contract for an agent (the company’s CEO), whose action is partly unobserved by. Holmström’s informativeness principle stated precisely how this contract should link the agent’s pay to performance-relevant information. Using the basic principal-agent model, he showed how the optimal contract weighs risks against incentives. In later work, Holmström generalised these results to more realistic settings, namely: when employees are not only rewarded with pay, but also with potential promotion; when agents expend effort on many tasks, while principals observe only some dimensions of performance; and when individual members of a team can free-ride on the efforts of others.

In the mid-1980s, Oliver Hart made fundamental contributions to the issue of incomplete contracts. Because it is impossible for a contract to specify every eventuality, this branch of the theory spells out optimal allocations of control rights: which party to the contract should be entitled to make decisions in which circumstances? Hart’s findings on incomplete contracts have shed new light on the ownership and control of businesses and have had a vast impact on several fields of economics, as well as political science and law. His research provides us with new theoretical tools for studying questions such as which kinds of companies should merge, the proper mix of debt and equity financing, and when institutions such as schools or prisons ought to be privately or publicly owned.

A detailed review of the Laureates’ work is available on the Nobel Prize website:


EEA award goes to Lucrezia Reichlin

The European Economic Association has awarded the Birgit Grodal prize to Lucrezia Reichlin, of London Business School.

The award is named after Birgit Grodal, who was the first female elected President of the EEA, but sadly passed away before she was due to take up her presidency (see RES Newsletter April 2005). The Birgit Grodal Award is made every even year to a European-based female economist who has made a significant contribution to the economics profession and the first three editions have sponsored by the Danmarks Nationalbank.

Lucrezia’s research is in applied time series, business cycle and monetary policy. With others, she has pioneered econometric methods for analysing a large number of time series: dynamic factor models, shrinkage methods and Bayesian vector auto-regressions. Some of these ideas have been used to develop a framework for ‘Now-Casting’. This is defined as the prediction of the present, the very near future and the very recent past. More broadly we can define it as the exercise of reading, through the lenses of a model, the flow of data releases in real time. The term is a contraction for now and forecasting and has been used for a long-time in meteorology. Lucrezia is a co-founder and Director of Now-Casting Economics Ltd (https://www.now-casting.com/).

Professor Reichlin has been a consultant for several central banks around the world. Her work on monetary policy has focused on documenting monetary analysis at the European Central Bank, where she was Director of Research from 2004 to 2008, and, more recently, on understanding the effect of its policies during the crisis.

Lucrezia Reichlin is Professor of Economics at London Business School; Non-Executive Director of UniCredit Banking Group; Research Director at the Centre for Economic Policy Research; and Chair of the Scientific Council at the Brussels-based think-tank, Bruegel. She received her PhD from New York University after earlier obtaining her Laurea at the University of Modena. She was elected Fellow of the British Academy in 2013 and a Fellow of the Econometrics Society in November last year.

Pervious winners of the Birgit Grodal Award are Rachel Griffith (University of Manchester and IFS, 2014) Hélène Rey (London Business School, 2012).