Edmund S. Phelps, Nobel Prize Winner in Economics

October 11, 2006 at 11:30 pm (Economics, US)

From the New York Times:


Edmund S. Phelps, a Columbia University professor, was awarded the Nobel Memorial Prize in Economic Science yesterday for his contribution to a sophisticated explanation of how wages, unemployment and inflation interact with one another.

The explanation holds, in essence, that wages and inflation tend to rise in tandem, one pushing up the other, until the unemployment rate reaches an “equilibrium” or “natural” level at which prices no longer rise.

These trade-offs are often considered by Federal Reserve policy makers in setting interest rates and are still a central element of mainstream economic thinking. But the relationships among these factors have eroded over time, many economists say, contributing to assertions from both the left and the right that the Fed has sometimes gone too far in squeezing economic growth in pursuit of a theory that no longer fits the real world.

Mr. Phelps, who is 73, is a latecomer to the Nobel for work in this field. He elaborated in the late 1960’s on a concept first introduced by A. William Phillips, a British economist. Mr. Phillips described, in a 1958 paper, how lower unemployment pushes up wages and vice versa. The trade-off came to be known as the Phillips curve, and the name stuck through various permutations.

Mr. Phelps brought inflation into the equation, and also inflationary expectations. So did Milton Friedman, almost simultaneously, and in the Nobel that Mr. Friedman won in 1976, this work was included in the citation.

“Ned Phelps was clearly on everybody’s short list to win a Nobel,” said Robert M. Solow, himself a Nobel laureate in economics.

Six Nobels for 2006 have been awarded so far, and all have gone to Americans. Mr. Phelps, in addition, is the fourth economist at Columbia to win a Nobel in the last decade. The award, which carries a prize of $1.37 million, also cited his work in analyzing the intricate relationship between behavior and expectations and the role of investment in education and research.

But Mr. Phelps was mainly recognized for his contributions to an understanding of the trade-offs involving inflation, wages and unemployment. He offered more detail than Mr. Friedman about how expectations are formed and how they are affected by incomplete knowledge.

Neither workers nor managers have enough information, Mr. Phelps found, to accurately assess what is happening to wages and prices and each, in making its demands, is susceptible to miscalculation.

“I’ve tried to put people into economic models by being more realistic about the situations in which they find themselves,” Mr. Phelps said in an interview yesterday. He learned of the award in a 6 a.m. telephone call from Stockholm where the Swedish Academy of Science, which selects Nobel winners, has its headquarters.

“My wife took the call and passed the phone to me,” Mr. Phelps said.

The Phillips curve, as elaborated by Mr. Friedman and Mr. Phelps, holds in effect that in the early stages of a wage-price spiral, both workers and managers settle for increases that are less than actual inflation. But gradually a wage-price spiral develops, and prices rise without any change in the unemployment rate.

Finally, there is a reaction. As the economy heats up, central bankers step in to push up interest rates in an effort to control inflation by slowing the economy. The unemployment rate begins to rise, and if the nation is lucky, unemployment settles at the natural rate, which means the rate at which inflation holds steady.

In the 1980’s and early 90’s, economists put this natural rate as high as 6 percent, and the Fed, aiming for this target, sometimes ended up pushing the economy into higher unemployment and recessions.

“For me,” Mr. Solow said, “there was really only one short period, in the 1970’s, when this theory really worked.”

Employers then had more power to raise prices than they do in today’s global economy, and workers had stronger unions to help them bargain for higher wages. “Since the 1970’s,” Mr. Solow said, “the natural rate of unemployment, this key rate, has been very unstable.”

Indeed, Fed policy makers found in the 1990’s that unemployment could fall much more than they anticipated without causing inflation to escalate.

“At this point,” said Jared Bernstein, a senior economist at the labor-oriented Economic Policy Institute, “the concept does more harm to the country than good.”

Mr. Phelps himself has become less than enchanted by his findings. “The ‘natural unemployment’ rate,” he said, “leaves people with the idea that there is no hope. It is an act of nature that cannot be repealed by man.”

Mr. Phelps was born in Evanston, Ill., but at age 6 he moved to a New York suburb, Hastings-on-Hudson, after his parents lost their jobs in the Depression and his father found a new one in Manhattan.

At Amherst College, he took a course in economics to please his father, and found himself hooked, particularly by the issue of unemployment. He received his Ph.D. from Yale in 1959 and joined the Columbia faculty in 1971 after teaching stints at the Massachusetts Institute of Technology, Yale and the University of Pennsylvania.

He and his wife, Viviana Montdor Phelps, an interpreter fluent in four languages, have lived for 32 years in a three-bedroom apartment overlooking Central Park. They own neither a car nor a country home, not wanting the bother of maintaining a second residence, Ms. Phelps said. They like to travel, including trips to Argentina, his wife’s native country.

“We never had enough money to buy an apartment as large and as comfortable as the one we live in,” she said, “and the rent for this one is relatively low.”




  1. Justin Alexander Caveda said,

    Hey, congrats Big Ned

  2. Dr.VSR.Subramaniam said,

    Nobel Laureate Edmund.S.Phelps’s analysis on the short and long time trade offs in macroeconomic policy, jives with the prime doctrines in “Artha Sasthra”, created by “Kautilya”, also known as “Chanakya”. He was the Politico-Economic adviser to Chandra Guptha Maurya, the ruler of a large empire in India during the 4th Century BC. It was an Economics strategy manual, with 15 Chapters, 380 sanskrit versus and 4968 rules. According to Chanakya, “Today’s economic thoughts serves as a food for the development strategy, spreads and trades off for the Current century. How is a King with a given ruling strategy, is reflected on the disciplines of the citizens. The available economic power at any point of time decides the economic development of that period”. (In Sanskrit, “Yatha Dhivasa Yojana, Thatha Kalpa Bojana. Yatha Rajaaha, Thatha Prajaaha. Yathah Sakthihi Thatha Vridhdhihi”).

  3. Idetrorce said,

    very interesting, but I don’t agree with you

  4. Bob said,

    Edmund S. Phelps is why the US economy is in recession! Take away our dreams and what is left?

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