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The first question that got Nancy Stokey interested in economics was about income inequality between countries.

As far back as high school she pondered why there were such yawning gaps between people’s incomes in places like the U.S. compared to other parts of the world, such as sub-Saharan Africa or parts of Asia. She wondered why the whole world wasn’t developed and how poorer countries could eventually get richer. “It seemed like economics was the obvious place to start trying to find some answers,” Stokey says.

It's a question she’s returned to during her lengthy career. She admits it’s a hard one to answer, but she still thinks economics, education and technology may hold the key.

Her pursuit of answers to hard questions around topics like economic development, market pricing and fiscal and monetary policy have positioned Stokey as an influential economist around the globe. For her achievements, Stokey is the winner of the 16th CME Group-MSRI Prize in Innovative Quantitative Applications.

Since 1990, Stokey has been the Frederick Henry Prince Distinguished Service Professor of Economics at the University of Chicago where she focuses on mathematical economics. She has a bachelor of arts in economics from the University of Pennsylvania and a PhD in economics from Harvard.   

Rational Expectations and Common Knowledge

Stokey is known for several foundational writings, including the very first paper she wrote, “Rational Expectations and Durable Goods Pricing” (1981). The research explored the conditions under which a durable-goods seller without commitment power is able to appropriate any of the gains from trade.

Her paper co-written with 2017’s MSRI Prize-winner and 2020 Nobel Prize-winning economist Paul Milgrom, “Information, Trade, and Common Knowledge” (1982), is a pillar of modern finance, showing that for rational agents, trade based on new information alone is not possible in a setting with complete competitive markets.

When that paper was published, Stokey says, it came as a surprise that if markets are complete---in a very precise sense, when a market participant receives a new piece of information, there’s no room for further trade. If one trader receives the information, his willingness to trade provides a signal to all the rest, and all of their beliefs will change in the same way. They will then be unwilling to trade with the first-informed agent.  Stokey says what was most amazing to her was that she and Milgrom could make a definitive statement about market function, since markets were already so well-studied.

The work, Milgrom now says, “left space for new ideas, which offer interesting new perspectives about trading volume, price volatility, and excess returns on certain investments.”

Milgrom calls Stokey “a leader in expositing dynamic economics and incorporating it into foundational economic theories.”

Stokey was at Northwestern University in the 1980s with Milgrom when they jointly wrote the paper. Bengt Holmstrom, the 2013 MSRI Prize-winner and Nobel laureate, was a fellow Northwestern colleague, as was Nobel laureate Roger Myerson.

“Upon reflection, our days together remind me of how powerful it is to have a group of young scholars interacting as intensively as we did then, encouraging one another and setting a very high bar for what good research could be,” said Milgrom.

"Nancy is a leader in expositing dynamic economics and incorporating it into foundational economic theories.”

- Nobel laureate Robert Milgrom

Recursive Methods

The textbook she wrote with Robert Lucas, Recursive Methods in Economic Dynamics (1989) is a classic, still widely used for first-year graduate economic programs.  Her 1984 paper with Lucas on “Optimal Growth with Many Consumers” extended the methods of dynamic programming to a new class of models, where a key assumption on preference over payoff streams is relaxed. Her 1998 paper with Fernando Alvarez on “Dynamic Programming with Homogeneous Functions” extended them to models with long-run growth.  

Fiscal Policy Use in Covid-19

Stokey and Lucas also wrote a paper on optimal fiscal and monetary policy, specifically looking at why countries typically want to borrow money during war time and want to pay back those debts when the war is finished, to retain borrowing capacity in case of future spending demands.

The massive fiscal stimulus passed by Congress at the onset of the Covid-19 pandemic two years ago has no peer, Stokey says, noting the only other time fiscal policy spending is so dramatic happens during wars. Broadly speaking, Congress’s decision to support the economy was the right thing to do, she adds.

The fiscal spending the last two years was to protect people from what would have been potentially devastating effects of the lockdown during the pandemic, she says, noting that the people who lost their jobs would have been in very dire straits.

“I'm sure you can quibble about different aspects of the policies. Could it have been done better? Probably…. During a crisis, you have to do something right away. You don't have time to fine tune every aspect of the policies,” she says.

Pandemic era fiscal policy was met with extraordinary monetary policy, too, eventually stoking inflation. Now the Federal Reserve has a difficult path to steer, as they try to tamp down on inflation but not send the economy into a tailspin, Stokey says.

It’s taken longer for inflation to appear in the economy than she expected, she adds, saying she  thought inflation would have picked up during then-Federal Reserve President Ben Bernanke’s tenure when he started the quantitative easing program and balance-sheet expansion during the 2008 global financial crisis. 

“I've been waiting for inflation since then. So much for my forecasting abilities,” she quips.

Whether or not the Fed can engineer a soft landing is anyone’s guess, she says, and she doubts that anyone really knows, including Fed officials. “Anybody who says they know is bluffing,” Stokey says.

Still Thinking About Inequality

At this point in her career, Stokey is returning to the question that first interested her in economics. She’s taking another look at inequality, and how poorer countries can catch up with wealthier countries. She is looking to places such as China, Taiwan and South Korea as examples of countries that have narrowed the economic inequality gap for possible evidence of how to replicate that elsewhere.

Technology may hold the key. Her working hypothesis is that getting technology and the relevant expertise to poor countries may create an incentive by citizens to acquire the education they need to adopt these technologies and increase production. It is research that may bring her closer to finding the answers she first sought as a teenager.

“Technology transfer may be the key to success,” she says.



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