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Nobel economists say euro zone needs fiscal union

Nobel Prize for Economics winner Professor Christopher Sims of Princeton University speaks during a news conference at Princeton
Nobel Prize for Economics winner Professor Christopher Sims of Princeton University speaks during a news conference at Princeton

By Walter Brandimarte, Simon Johnson and Veronica Ek

STOCKHOLM/PRINCETON, New Jersey (Reuters) - Two Americans were awarded the Nobel prize for economics on Monday for work that was lauded as laying for foundation for modern macroeconomic analysis, but the two winners said they had no easy answers for the debt crisis plaguing Europe.

Christopher Sims and Thomas Sargent were awarded the prize by the Royal Swedish Academy of Sciences for their work that governments can use to gauge the effects of policy.

But even without any clear answers on a way out for Europe from its debt crisis, Sims said the euro zone must create a fiscal union to avoid the collapse of its common currency.

"If the euro is to survive, the euro area will have to work out a way to share fiscal burdens," Sims said in a press conference at Princeton University, where he is a professor.

Governments of the 17-nation euro zone are trying to resolve a debt crisis that threatens to spread from weaker economies in Greece, Portugal and Ireland to the region's bigger counties, including Italy. Much of Europe shares the euro currency but individual countries do not vouch for one another's debts.

The European Central Bank could need some "central fiscal backing" by euro zone countries, Sims added.

PANICS AND CRISES

The two American economists conducted separate research in the 1970s to model cause and effect in economies, including the complex interplay of tax and interest rate policies with the expectations of people and businesses.

"Panics and crises, ... what's going on in Europe now with the euro, that's all about expectations about what other people are going to do," Sargent, 68, a professor at New York University, said in an interview aired on the Nobel Prize organization's website.

For example, government spending to help a flagging economy could be less effective when people see the limits to state finances and expect the stimulus spending to run out.

But, while his research had provided ideas about how expectations influenced policies and their impact, Sargent cautioned that he, like Sims, had no simple solution to the global economic crisis. "We try to experiment in our models before we wreck the world," Sargent said.

Sims, also 68, noting the world's present financial troubles, said that reviving the world economy "requires a lot of slow work looking at data, unfortunately."

But, he added, "the methods that I have used and that Tom has developed are essential to finding our way out of this mess."

The two Nobel prize winners said they also did not have any magic bullet for solving the U.S. economy's woes, but Sargent criticized the way in which the country's fiscal problems are often discussed.

It's not really a question of whether the U.S. fiscal outlook is sustainable, but a question of which government promises will not be honored, Sargent said.

Some promises made by the U.S. government, namely those regarding taxes or government pension and health programs for retirees, simply will not be honored, he said.

"It's not clear which of these incredible promises will be broken first," Sargent said.

Lawmakers in Washington are grappling with how to reduce the United States' budget deficit, which stood $1.3 trillion, or 8.6 percent of gross domestic product, for the recently ended 2011 fiscal year. The battle has sparked sharp partisan debate over spending cuts versus tax increases.

THE VALUE OF CAUSE AND EFFECT

The Royal Swedish Academy of Sciences said it made the 10 million crown ($1.5 million) award in honor of "empirical research on cause and effect in the macroeconomy."

( http://www.nobelprize.org/nobel_prizes/economics/ )

"One of the main tasks of macroeconomic research is to comprehend how both shocks and systematic policy shifts affect macroeconomic variables in the short and long run," the Academy said in a statement. "Sargent's and Sims's awarded research contributions have been indispensable to this work."

The economics prize, officially called the Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel, was established in 1968. It was not part of the original group of awards set out in dynamite tycoon Nobel's 1895 will but was established by Sweden's central bank, the Riksbank.

Sargent developed a mathematical model in his work and described it in a series of articles in the 1970s. Sims wrote an article in 1980 which introduced a new way of analyzing data using a model called vector-autoregression.

"If we want to understand the role of economic policy in the society, we must have a notion of cause and effect," said Tore Ellingsen, from the Stockholm School of Economics and another member of the prize committee.

"And these methods help us to look at historical data and disentangle what caused what. This is used very widely. Finance ministries, central banks, universities ... all over the world."

(Additional reporting by Simon Johnson, Veronica Ek, Patrick Lannin and Mia Shanley in Stockholm; Editing by Alistair Macdonald and Clive McKeef)

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