The Prize in Economic Sciences goes this year to Edmund Phelps. His work has deepened our understanding of the relation between short-run and long-run effects of economic policy. These contributions have had a decisive impact on research as well as policy.
The Royal Swedish Academy of Sciences has decided to award the Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel for 2006 to Edmund S. Phelps, Columbia University, NY, USA, “for his analysis of intertemporal tradeoffs in macroeconomic policy”.
Short run – Long run
The work of Edmund Phelps has deepened our understanding of the relation between short-run and long-run effects of economic policy. His contributions have had a decisive impact on economic research as well as policy.
Low unemployment and low inflation are central goals of stabilization policy. During the 1950s and 1960s the view of a stable tradeoff between inflation and unemployment was established, the so-called Phillips curve. According to this, the price for reduced unemployment was a one-time increase of the inflation rate. Phelps challenged this view through a more fundamental analy-sis of the determination of wages and prices, taking into account problems of information in the economy. Individual agents have incomplete knowledge about the actions of others and must base their decisions on expectations. Phelps formulated the hypothesis of the expectations-augmented Phillips curve, according to which inflation depends on both unemployment and inflation expectations.
As a consequence, the long-run rate of unemployment is not affected by inflation but only determined by the functioning of the labor market. It follows that stabilization policy can only dampen short-term fluctuations in unemployment. Phelps showed how the possibilities of stabilization policy in the future depend on today’s policy decisions: low inflation today leads to expectations of low inflation also in the future, thereby facilitating future policy making.
Another issue where intertemporal tradeoffs are of central importance concerns the desirable rate of capital formation. By foregoing consumption for investment in physical as well as human capital (education and research), today’s generation can raise the welfare of future generations. Phelps clarified possible distributional conflicts among generations. He also showed that all gen-erations may, under certain conditions, gain from changes in the savings rate. Phelps also pioneered the analysis of the importance of human capital for the diffusion of new technology and, hence, for growth.
- Edmund S. Phelps, born 1933 (73) in Evanston, IL,USA (US citizen). PhD in economics in 1959 from Yale University, CT, USA. McVickar Professor of Political Economy at Columbia University, NY, USA.
The Prize amount: SEK 10 million