An Interview with Chris Sims, 2011 Nobel

Laureate
April 2, 2012
Nobel Prize winner Chris Sims explains the economic impact of monetary policy, compares
European and U.S. policy models, and shares practical advice for budding economists.
Gary Tapp: Today we are delighted to welcome Dr. Christopher Sims who together with
Thomas Sargent was awarded the 2011 Nobel Prize for Economic Science. Dr. Sims is
currently the Harold B. Helms Professor of Economics and Banking at Princeton University. Dr.
Sims, welcome to the Classroom Economist.
Economist

Sims: Thanks. Glad to be here.

Tapp: For high school economics teachers, how would you suggest that they introduce the
basic idea of econometric modeling to their students?
Sims: The essence of econometric modeling is that it's statistics applied to economics. What
econometric models do and what they're used for could be taught at the high school level. The
idea is that there's lots of data available and new data coming in every month, and people who
make economic policy need
d to find some way to make sense of that data and use it to guide
their decisions. That means that you have to keep track of it, you need a spreadsheet or
something at least, and you need some way to say, well, now that the exchange rate has gone
up 10 percent,
cent, what does that mean for what we think is going to happen to inflation? That's
what econometric models are for, to help policymakers react to the flow of data. I think it's also
important... it's not impossible to teach statistics to high school students,
students, and I think high school
students should be getting more of an introduction to statistics and probability than is standard,
and that should be coordinated if economics is being taught and statistics is being taught in the
high school, you can be linking
linkin them.
Tapp: So, if I asked you to describe the main contribution of your work to the field of economic
modeling and maybe relating back to the traditional model, how would you describe that?
Sims: I think that what the Noble Prize people were singling out
out was that my work helped sort
out the dispute between the monetarists and Keynesians. They, in part by introducing new
approaches to statistical modeling in the '60s and early '70s, monetarists were claiming that the
main source of business cycle fluctuations
fluctuations was bad monetary policy. The monetary authority
was making mistakes, making the growth rate of money vary a lot, and all those variations

resulted in recessions and booms, and if only we could force the monetary authority to stop
messing with the economy and just keep money growth steady, the business cycle would be
greatly reduced or even vanish.
And then the Keynesians were saying that can't be true, but they didn't have statistical models
in which they could each put forward their position and ask, well, what did the data say? There
were 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 managed
to sort out what the effects of monetary policy changes are and distinguish those from comovements in money and prices and income that didn't have anything to do with policy. There's
now pretty much a consensus on how monetary policy affects the economy, and on what the
size of that effect is. The general conclusion is that it accounts for maybe somewhere between
zero 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 economic
forecasts in the media sometimes and their impression is that they're not that accurate. So, the
question is, what does the current research say about the forecasting accuracy of models, even
the latest generation of models?
Sims: Well, you have to recognize that no model claims that its point forecast is going to be
correct; these are probability models. If you see a forecast that says growth will be 2.3 percent
next 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. How
likely 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 be
thought of as telling us what the range of uncertainty is, and unfortunately, people often... when
a model that does a good job of describing the real range of uncertainty is sometimes dismissed
as too inaccurate. If I say, the best I can tell you is that the probability is 80 percent growth will
be between 2 percent and 3 percent, that may be perfectly accurate. Somebody else comes
along and says it will be 2.5 percent plus or minus 0.1 and sometimes people think, well, that
guy's much more accurate than that guy that says 2 to 3 percent. That is, he seems much more
sure 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 big
mistakes.
Tapp: Some observers have suggested that the pace of financial innovation over the last 10 or
15 years or so exceeded the pace of development of risk management models and that might
have contributed some to the crisis of 2008. More broadly, other observers have suggested that
macroeconomic models themselves don't have enough of a financial component to them. Would
you agree with either the narrow comment about risk management models or the broader model
or both of them?
Sims: It's true that financial innovation has been rapid recently. There's a constant tension
between 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 mean
that there's an incentive for somebody to write those contracts and you have to create barriers
to doing it. Well, the same incentives that lead to that contract in the beginning are going to lead
to people who are going to try to think of ways around any regulation you propose, and that's
never going to change. It's a hard problem to see how you avoid new systemic dangers coming
up through too slow a speed of response by the regulators. Econometric models, it's true, have
not had much of a financial sector in the past and they should have had more. If you looked
back historically, you could have seen...we are now seeing when we look at past data, that if
we'd had some financial variables in the models, we would have done a better job of tracking
what was going on in 2007–2008 and going forward, every policy institution has people
working on new models with bigger financial sectors. I'm a little afraid that we're following the
usual tendency to fight the last war. We've had a big financial crisis, going forward it may not be
financial crisis so much as public finances, debt and deficits, that are the important thing and
those have been neglected in these models, too.
Tapp: The current situation in Europe, you have done some work in that area and spoken and
written about possible lessons that the current crisis might have for the U.S. Could you just
outline what you think some of those lessons might be at this point, given that the situation is
still unfolding?
Sims: The sources of the European crisis is that they made some changes in their institutions
that took them away from the U.S. model. In the U.S., we have our own currency, an exchange
rate between that currency and the rest of the world, and strong fiscal central
authority—the federal government that taxes and spends and issues debt. We have state
governments also, but they do not have their own currencies, and they have balance budget
requirements in their constitutions for the most part.
In Europe, they have a central bank that's like our Fed, but there is no corresponding fiscal
authority. There is a European Union that does do a little bit of taxing and spending, but it's very
tiny and it does not issue debt backed by a European-wide taxing commitment. It's that situation
that's causing them their difficulties. They have all these countries, none of whom can issue
their own currency, none of whom can devalue, and they don't have the network of fiscal
cushions that we have.
In our country, if there's a housing crisis in Texas and Boston is doing well, which has happened
at some points historically, without anyone thinking about it, tax money flows from Boston to
Texas because we have an income tax. Incomes are down in Texas, they're up in
Massachusetts, 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 in
economic difficulty like Greece and Spain and Portugal, they find that they don't have the option
of borrowing with their own currency, they don't have the option of devaluing to make
themselves more competitive, and yet at the same time there is no corresponding fiscal cushion
the 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 going
on 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 bit
worrisome in teaching college students is some of the best students have taken advanced
placement calculus in high school and then they arrive in college and they stop taking math
because they've met the requirements. And then in junior year, they decide they want to take an
advanced economics course, and they haven't done any math for two years, and they get very
rusty. I think it doesn't matter quite so much exactly what math you're taking, but you should
keep at it to keep your skills up in high school and after high school. It's not like there's a certain
amount of math you need to learn and then you can quit. Whatever level you're at, you should
be keeping your skills sharp and trying to advance in math. So, I think that's the single most
important 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 courses
and 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 you
were first exposed to economics in school? What attracted you to the field, and what made you
eventually 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 going
through high school, there were very few high schools that taught any economics. I had an
uncle, 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, my
grandfather was a labor economist. He was a member of the first of the National Labor
Relations Board under President [Franklin D.] Roosevelt. So, there was talk about economic
policy issues in family gatherings. My grandfather used to greet me from the time I was about
eight years old with, "Well, Chris, what do you think of the present situation of the country?" So I
knew about public policy issues and was familiar with discussing them from my family
background. I had a pretty good idea of what economists... what kinds of issues economists
deal 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 to
spend my life with pure abstraction, and I knew what economics was all about because of my
uncle. I also had an excellent math teacher in high school who went on to become the president
of the math teachers association—I can't remember the name of the association
[National Council of Teachers of Mathematics]—Stephen Willoughby, and he actually told
my 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. Thank
you so much for joining us.
Sims: Well, thanks for having me.