New inflation thinking captures Nobel Prize

Scott Tong Oct 9, 2006

KAI RYSSDAL: Columbia University economist Edmund Phelps is $1.4 million richer today. And he probably won’t even mind paying the currency exchange costs. The actual check’s going to be for 10 million Swedish kroner. Phelps won the Nobel Memorial Prize in Economics this morning. He’s long been considered a giant in the field of macroeconomics. The stuff the Federal Reserve pores over. Things like jobs, wages and prices and how they all connect. Marketplace’s Scott Tong reports.

SCOTT TONG: In a field known as the dismal science, Ned Phelps is apparently a colorful man. Phelps wrote that one of his early professors treated economics lectures like white wine — the drier the better.

So when Phelps became a teacher, he was cool.

NARIMAN BEHRAVESH: I wouldn’t say he was a flashy dresser, but he was a dapper kind of dresser.

Economic forecaster Nariman Behravesh studied under Phelps in the 1970s. He says Phelps challenged the conventional wisdom that inflation is only tied to unemployment.

Phelps said what also matters is people’s expectations. If businesses and consumers think prices will go up, they’ll panic buy and prices will go up. So for the Fed to guide the economy, a big key is to manage expectations.

BEHRAVESH: It’s been clear in terms of what the Fed’s done — really starting in the late 70s under Paul Volcker, and then during the Greenspan years, and more recently in the Bernanke era — that they will do whatever is necessary to keep inflation in check.

Phelps also introduced a concept of the natural rate of unemployment, which argues that policymakers who try to push down the jobless rate too much will fail. In the long run, unemployment will always float back up.

Greg Mankiw teaches economics at Harvard.GREG MANKIW: Regardless of what inflation rate the Fed chooses, the unemployment rate’s gonna be basically the same. The unemployment rate will depend on a variety of things — such as labor laws and the role of unions and minimum wages — but it’s not going to depend on the rate of inflation.

Mankiw calls Phelps’ work a starting point for modern theories of economics.

In Washington, I’m Scott Tong for Marketplace.

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