an interview with chris sims

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An Interview wiLaureate

April 2, 2012

Nobel Prize winner Chris SimEuropean and U.S. policy mo

Gary Tapp: Today we are deThomas Sargent was awardecurrently the Harold B. HelmsSims, welcome to the Classr

Tapp: For high school econobasic idea of econometric mo

Sims: The essence of econoeconometric models do andidea is that there's lots of datmake economic policy need ttheir decisions. That means tsomething at least, and you nup 10 percent, what does thawhat econometric models areimportant... it's not impossible

students should be getting mand that should be coordinathigh school, you can be linkin

Tapp: So, if I asked you to dmodeling and maybe relating

Sims: I think that what the Nout the dispute between theapproaches to statistical mod

main source of business cyclwas making mistakes, makin

th Chris Sims, 2011 Nobe

s explains the economic impact of monetary polidels, and shares practical advice for budding ec

lighted to welcome Dr. Christopher Sims who tod the 2011 Nobel Prize for Economic Science. DProfessor of Economics and Banking at Princetom Economist .

ims: Thanks. Glad to be here.

ics teachers, how would you suggest that they ideling to their students?

etric modeling is that it's statistics applied to echat they're used for could be taught at the high savailable and new data coming in every month,find some way to make sense of that data and

at you have to keep track of it, you need a spreeed some way to say, well, now that the exchanmean for what we think is going to happen to inffor, to help policymakers react to the flow of datto teach statistics to high school students, and I

re of an introduction to statistics and probabilityd if economics is being taught and statistics is bg them.

scribe the main contribution of your work to the fback to the traditional model, how would you de

ble Prize people were singling out was that myonetarists and Keynesians. They, in part by intr

eling in the '60s and early '70s, monetarists were

fluctuations was bad monetary policy. The monthe growth rate of money vary a lot, and all thos

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ntroduce the

nomics. Whatchool level. Theand people whose it to guide

dsheet ore rate has gonelation? That's. I think it's alsothink high school

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ield of economiccribe that?

ork helped sortducing newclaiming that the

etary authoritye variations



resulted in recessions and booms, and if only we could force the monetary authority to stopmessing with the economy and just keep money growth steady, the business cycle would begreatly reduced or even vanish.

And then the Keynesians were saying that can't be true, but they didn't have statistical modelsin which they could each put forward their position and ask, well, what did the data say? Therewere lots of attempts to do that, but with very awkward statistical modeling.

Over the course of about 10 years, things that I did and other people followed up on managedto sort out what the effects of monetary policy changes are and distinguish those from co-movements in money and prices and income that didn't have anything to do with policy. There'snow pretty much a consensus on how monetary policy affects the economy, and on what thesize of that effect is. The general conclusion is that it accounts for maybe somewhere betweenzero and 20 or 25 percent of the fluctuations we see, but if you try to trace out historically, you

can't blame any recession on monetary policy.

Tapp: One type of question that we get from teachers occasionally is, they see economicforecasts in the media sometimes and their impression is that they're not that accurate. So, thequestion is, what does the current research say about the forecasting accuracy of models, eventhe latest generation of models?

Sims: Well, you have to recognize that no model claims that its point forecast is going to becorrect; these are probability models. If you see a forecast that says growth will be 2.3 percentnext year, the model is not saying and if it's 2.2 percent I'll die, it's saying the most likely value is

2.3 percent, and if you really want to know what the model says you should ask more. Howlikely is it that it will be 2 percent or less, how likely is it that it will be 3 percent or more?Because a good model, the modern ones, answer those questions, the forecast should bethought of as telling us what the range of uncertainty is, and unfortunately, people often... whena model that does a good job of describing the real range of uncertainty is sometimes dismissedas too inaccurate. If I say, the best I can tell you is that the probability is 80 percent growth willbe between 2 percent and 3 percent, that may be perfectly accurate. Somebody else comesalong and says it will be 2.5 percent plus or minus 0.1 and sometimes people think, well, thatguy's much more accurate than that guy that says 2 to 3 percent. That is, he seems much moresure of himself, but if you look historically, it may be that he is over and over again wrong.

People who seem really sure of themselves are often people who over and over again make bigmistakes.

Tapp: Some observers have suggested that the pace of financial innovation over the last 10 or15 years or so exceeded the pace of development of risk management models and that mighthave contributed some to the crisis of 2008. More broadly, other observers have suggested thatmacroeconomic models themselves don't have enough of a financial component to them. Wouldyou agree with either the narrow comment about risk management models or the broader modelor both of them?

Sims: It's true that financial innovation has been rapid recently. There's a constant tensionbetween regulation and financial innovation. What regulation does is try to control some kinds of



financial contracts that create systemic problems, and if there's a need for control it must meanthat there's an incentive for somebody to write those contracts and you have to create barriersto doing it. Well, the same incentives that lead to that contract in the beginning are going to leadto people who are going to try to think of ways around any regulation you propose, and that'snever going to change. It's a hard problem to see how you avoid new systemic dangers comingup through too slow a speed of response by the regulators. Econometric models, it's true, havenot had much of a financial sector in the past and they should have had more. If you lookedback historically, you could have seen...we are now seeing when we look at past data, that ifwe'd had some financial variables in the models, we would have done a better job of trackingwhat was going on in 2007–2008 and going forward, every policy institution has peopleworking on new models with bigger financial sectors. I'm a little afraid that we're following theusual tendency to fight the last war. We've had a big financial crisis, going forward it may not befinancial crisis so much as public finances, debt and deficits, that are the important thing andthose have been neglected in these models, too.

Tapp: The current situation in Europe, you have done some work in that area and spoken andwritten about possible lessons that the current crisis might have for the U.S. Could you justoutline what you think some of those lessons might be at this point, given that the situation isstill unfolding?

Sims: The sources of the European crisis is that they made some changes in their institutionsthat took them away from the U.S. model. In the U.S., we have our own currency, an exchangerate between that currency and the rest of the world, and strong fiscal centralauthority—the federal government that taxes and spends and issues debt. We have stategovernments also, but they do not have their own currencies, and they have balance budgetrequirements in their constitutions for the most part.

In Europe, they have a central bank that's like our Fed, but there is no corresponding fiscalauthority. There is a European Union that does do a little bit of taxing and spending, but it's verytiny and it does not issue debt backed by a European-wide taxing commitment. It's that situationthat's causing them their difficulties. They have all these countries, none of whom can issuetheir own currency, none of whom can devalue, and they don't have the network of fiscalcushions that we have.

In our country, if there's a housing crisis in Texas and Boston is doing well, which has happenedat some points historically, without anyone thinking about it, tax money flows from Boston toTexas because we have an income tax. Incomes are down in Texas, they're up inMassachusetts, and there's a net flow of resources through the federal government that way.

There is no corresponding automatic cushion in Europe. So, these countries that are ineconomic difficulty like Greece and Spain and Portugal, they find that they don't have the optionof borrowing with their own currency, they don't have the option of devaluing to makethemselves more competitive, and yet at the same time there is no corresponding fiscal cushionthe way there is in the U.S. So, these are all lessons in a way that tell us we ought to be

thankful that our system is a lot better set up than theirs.



Tapp: For a high school teacher who has students that they think might be interested in goingon further into economics, how would you suggest that they prepare themselves?

Sims: Taking math courses steadily is very important. One of the things that I've found a little bitworrisome in teaching college students is some of the best students have taken advancedplacement calculus in high school and then they arrive in college and they stop taking mathbecause they've met the requirements. And then in junior year, they decide they want to take anadvanced economics course, and they haven't done any math for two years, and they get veryrusty. I think it doesn't matter quite so much exactly what math you're taking, but you shouldkeep at it to keep your skills up in high school and after high school. It's not like there's a certainamount of math you need to learn and then you can quit. Whatever level you're at, you shouldbe keeping your skills sharp and trying to advance in math. So, I think that's the single mostimportant thing. Of course, if all you do is take math courses that can be a creative gap, too.Economics is about the application of math to the real world, and you do have to take coursesand be interested in other things as well; history and economics itself if it's taught in your school,and be interested in politics and how decisions are made in your country.

Tapp: I see that your undergraduate major was in mathematics. Can you talk about when youwere first exposed to economics in school? What attracted you to the field, and what made youeventually decide to go in that direction for your graduate work?

Sims: I actually didn't have any exposure in school to economics at the time I was goingthrough high school, there were very few high schools that taught any economics. I had anuncle, though, who was an economist who campaigned to get me to become an economist from

about the time I was 10 years old. I knew what an economist does from my uncle; also, mygrandfather was a labor economist. He was a member of the first of the National LaborRelations Board under President [Franklin D.] Roosevelt. So, there was talk about economicpolicy issues in family gatherings. My grandfather used to greet me from the time I was abouteight years old with, "Well, Chris, what do you think of the present situation of the country?" So Iknew about public policy issues and was familiar with discussing them from my familybackground. I had a pretty good idea of what economists... what kinds of issues economistsdeal with and why what they do might be interesting and important from a very early age.

I thought he [Sims's uncle] was having the opposite effect of what he intended, but when I got to

my senior year and I was considering going on in math, I decided that I probably didn't want tospend my life with pure abstraction, and I knew what economics was all about because of myuncle. I also had an excellent math teacher in high school who went on to become the presidentof the math teachers association—I can't remember the name of the association[National Council of Teachers of Mathematics]—Stephen Willoughby, and he actually toldmy mother that I should become an economist, but he never told me [laughs].

Tapp: We've been talking with Dr. Christopher Sims, Nobel Prize winner in economics. Thankyou so much for joining us.

Sims: Well, thanks for having me.

an interview with chris sims

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