An ice cream menu helped illustrate the economic theory behind this year’s Nobel Prize in Economics, as researchers highlighted how prices that do not adjust quickly can influence recessions, unemployment and inflation.
The prize recognized economists Robert Hall of Stanford University and Michael Woodford of Columbia University for work on the microeconomic foundations of macroeconomic stabilization. Their research helped establish the foundations of New Keynesian economics, a framework used to understand how individual decisions by households and businesses shape the wider economy.
At the prize announcement in Sweden, Timo Boppart, an economist at Stockholm University and member of the prize committee, used an ice cream menu to explain why businesses do not constantly change their prices as economic conditions shift.
Instead, a shop might set its prices for an entire season, even when demand or costs change. Economists call this phenomenon “sticky prices,” and the concept has significant implications for how economies respond to financial shocks.
How Keynesian Economics Recovered From the 1970s
The story begins with British economist John Maynard Keynes, whose influential work during the Great Depression challenged the idea that free markets would always restore economic stability on their own.
In The General Theory of Employment, Interest, and Money, Keynes argued that economies could remain trapped in prolonged downturns, with high unemployment and weak spending. He believed government intervention could help revive demand, create jobs and support recovery.
Keynesian ideas influenced generations of economists and policymakers. However, the economic turmoil of the 1970s, when inflation and unemployment rose simultaneously in a phenomenon known as stagflation, exposed weaknesses in the dominant Keynesian models.
Economists including Robert Lucas and Edward Prescott challenged these approaches, arguing that economic models needed stronger foundations in the decisions of individuals and businesses. They emphasized that people anticipate future policies and adjust their behavior accordingly, meaning historical patterns alone might not reliably predict the effects of new government measures.
Some alternative models, including real business cycle theory, assumed prices and wages adjusted flexibly enough to bring markets back into balance. Critics argued that this left insufficient room to explain why unemployment could persist during recessions.
Harvard economist Gregory Mankiw, who studied alongside Woodford at the Massachusetts Institute of Technology in the 1980s, said researchers such as Hall and Woodford sought to improve Keynesian economics rather than discard it entirely.
Why Sticky Prices Matter
Hall contributed to understanding how expectations about the future influence spending decisions in the present. Woodford developed this work into a framework that incorporated forward-looking behavior alongside prices that adjust slowly.
Consider an ice cream shop during a recession. If customers cut spending, the owner may not immediately reduce prices because changing menus costs money or because the business is uncertain whether the decline in demand will last.
The shop may consequently sell fewer ice creams rather than quickly adjusting prices to attract customers. If weaker sales persist, it could reduce employees’ working hours or lay off staff.
Similar dynamics apply across the economy, including to wages, which are not typically renegotiated every month. When demand falls but prices and wages remain relatively unchanged, businesses may reduce production and employment instead of allowing prices to adjust enough to restore demand.
This creates a potential role for government and central bank intervention. If prices and wages are slow to respond, monetary or fiscal policy can help support economic activity during a downturn.
How the Research Shapes Modern Central Banking
New Keynesian economics combines the importance of individual decision-making with the recognition that prices and wages may be rigid. The approach has become influential in how policymakers analyze recessions, inflation and the effects of interest rate decisions.
Woodford’s research also helped provide theoretical foundations for forward guidance, in which central banks communicate their intentions for future interest rates to influence expectations today.
During the Great Recession, the U.S. Federal Reserve reduced its benchmark interest rate close to zero. Under then-chair Ben Bernanke, it also signaled that rates would remain low for an extended period, aiming to reduce longer-term borrowing costs and encourage spending.
The Nobel recognition highlights how seemingly small details, such as how often a business changes its prices, can have economy-wide consequences. By combining forward-looking individual decisions with the reality of sticky prices, New Keynesian economics helped preserve Keynes’ central insight: markets do not always recover quickly from downturns without policy support.
