The messy science
Edmund Phelps’s academic achievements are so vast that when he received a phone call in October to tell him he’d won the Nobel Prize in economics, he didn’t quite know why. “I thought the prize was for my papers on economic growth, and at the Stockholm press conference, I was responding to questions that way,” says Phelps, McVickar Professor of Political Economy at Columbia. “I realized I was wrong only when a colleague alerted my wife, Viviana.”
The Nobel Prize, in fact, recognizes work that Phelps did in the late 1960s and early 1970s to refine the standard economic model regarding the relationship between unemployment and inflation. The Phillips curve, developed in 1958 by New Zealand economist A.W. Phillips, originally held that unemployment and inflation are directly and inversely related. Policymakers believed for many years that they could create jobs simply by tolerating high rates of inflation. It followed that unemployment couldn’t be lowered and inflation slowed at the same time.
Phelps studied this topic more closely and found that unemployment and inflation don’t have a neat and predictable relationship. He acknowledged that jobs are created in the short term by cutting taxes or interest rates, hence increasing consumer demand and the rate of inflation. But aggressive monetary policies have little impact on unemployment levels over the long term, Phelps found, in part because inflation is strongly influenced by human factors. For instance, workers and employers negotiate salaries based on what they believe will be average wage levels in the future, which makes those expectations self-fulfilling. “It’s a great big mess,” Phelps told The Los Angeles Times recently. “I think the messiness was not sufficiently appreciated earlier.”
Says economics chair Janet Currie: “Previously, there was a tendency to think about macroeconomics as a system divorced from the actions of individual people. Ned’s work has had a tremendous impact on all of macroeconomics.”
In his study of longitudinal economic trends, Phelps also developed the idea that modern economies have an “equilibrium unemployment level,” typically considered between 4 and 5 percent. When unemployment is at that desirable level, Phelps discovered, inflation stabilizes. But when policymakers attempt to drive unemployment below the tipping point, inflation accelerates steadily. Phelps’s ideas, which are similar to those developed by the late free-market theorist Milton Friedman ’46GSAS (see page 72), strongly influence the current policies of the Federal Reserve and other central banks. Most important, policymakers today believe that inflation and unemployment can both remain relatively low, and that interest-rate adjustments should correct short-term fluctuations in unemployment levels, rather than long-term employment trends.
A Columbia professor since 1971, Phelps is one of 13 current or former Columbia faculty members to have received the Nobel Prize in economics, and the fourth in the last decade. Most recently, University Professor Joseph Stiglitz won the award in 2001. Other Nobel laureates from the economics department include the late William S. Vickrey ’46GSAS, James Heckman, and University Professor Robert Mundell.
Phelps, 73, is also widely known for his work on how successive generations will benefit by the previous one’s forgoing consumption in favor of investment in physical capital, education, and research. In recent years, he has studied the dynamics of trade between the United States and China, the causes of economic booms, and the persistence of poverty in the United States. He now is studying the creativity of entrepreneurs, including the skills that financiers use to select projects for investment, and how managers evaluate and implement new business strategies. This research began in the early 1990s at the European Bank for Reconstruction and Development, where he worked on theories of capitalism and mass privatization in Eastern Europe. In 2001, Phelps cofounded the Center on Capitalism and Society at Columbia, which is now part of the Earth Institute.
A graduate of Amherst College and Yale University, Phelps found his calling by accident: As a student at Amherst, he took an economics course only at his father’s urging.
“This is a wonderful vote of validation by the economics profession,” says Phelps, who had been expected to win the prize for more than a decade.