STOCKHOLM (AFP) – US economist Edmund S. Phelps has won the Nobel Economics Prize for explaining how policies to deal with inflation and unemployment today can have big effects on behaviour and welfare in the future.
The Nobel committee honoured Phelps for his analysis of short- and long-term trade-offs in macroeconomic policy.
His work has “deepened our understanding of the relation between short-run and long-run effects of economic policy” and has had “a decisive impact on economic research as well as policy”, the jury said Monday.
Phelps, 73, is a professor of political economy at Columbia University in New York.
His work is at the centre of a vast debate on structural reforms, as industrialized countries attempt to restructure their economies to bring down unemployment and control inflation, while also containing deficits and debt, amid a need to fund future pension and health-care systems.
Policymakers in industrialised countries are trying increasingly to create conditions of economic stability so that people can plan without anticipating inflation, because anticipation can provoke unwanted economic consequences.
The citation said that his research had shown that while full employment, stable prices and rapid growth are central goals of economic policy, trade-offs sometimes need to be made between consumption by current and by future generations.
“He has emphasized that not only the issue of savings and capital formation but also the balance between inflation and unemployment are fundamentally issues about the distribution of welfare over time,” the Nobel committee said.
His analysis “clarified the limitations of macroeconomic policy”, and for example, central banks now base their interest rate decisions on other grounds than before, the jury noted.
Previously, economists believed that a fall in unemployment would cause a one-off rise in inflation. As a result, governments tended to regard inflation as a secondary problem to unemployment.
But in the late 1960s Phelps challenged that view.
“He recognized that inflation does not only depend on unemployment but also on the expectations of firms and employees about price and wage increases,” the jury said.
Phelps formulated a model known as the “expectations-augmented Phillips curve”, which says that for a given unemployment rate, a one percentage point increase in expected inflation leads to a one percentage point increase in actual inflation.
Maintaining low inflation can thus be regarded as an investment in low inflation expectations, enabling more favourable combinations of inflation and unemployment in the future than would otherwise be available.
“The innovative aspect of Phelps’ approach was that it started from explicit assumptions about the behaviour of individual agents in the labour market,” the Nobel committee said.
Phelps analysis stood in contrast to the earlier views on the ability of an expansionary fiscal and monetary policy permanently to increase employment.
“Instead his conclusion was that there is no long-run trade-off between inflation and unemployment, since inflationary expectations will adapt to the actual inflation,” the jury said.
Phelps will take home the prize sum of 10 million kronor (1.07 million euros, 1.37 million dollars).
The Nobel Economics Prize, the fourth of the six coveted prizes to be awarded this year, is the only one not originally included in the last will and testament of the creator of the awards, Swedish inventor Alfred Nobel.
It was created by the Swedish Central Bank in commemoration of its tricentenary in 1968, and was first awarded in 1969. It is also funded by the bank.
The United States has made a clean sweep of the Nobel prizes so far this year.
Last week, the Medicine Prize went to US research duo Andrew Fire and Craig Mello for their discovery of how to silence malfunctioning genes, a breakthrough which could lead to an era of new therapies to reverse crippling disease.
The Physics Prize went to US space scientists John Mather and George Smoot for a pioneering space mission which supports the “Big Bang” theory about the origins of the universe.
And Roger Kornberg of the US won the Chemistry Prize for work on a key process of life called genetic transcription.
The Literature Prize will be announced on Thursday and the Peace Prize on Friday.