A Prize for Economic Prophecy

Citing his "almost prophetic accuracy in terms of predicting the future development of international monetary arrangements," the Royal Swedish Academy of Sciences yesterday announced that it had awarded Columbia University economist Robert Mundell this year's Nobel Prize in Economics. Mundell's research, once considered esoteric and irrelevant, now provides the framework for virtually all analyses of international exchange rates and was used to establish the ground rules for the European Monetary Union.

The world was a very different place when Mundell received his Ph.D. from the Massachusetts Institute of Technology in 1956. "Capital flows were far less important" to domestic economies, says Princeton University economist Peter Kenen. A mere trickle of funds passed between countries compared to the estimated $2 trillion now exchanged on the international markets every day. And currencies were almost synonymous with their parent countries. "The idea of France and Germany sharing a currency seemed very oddball at the time," says Harvard University economist Ken Rogoff.

Perhaps it was his Canadian upbringing--Canada and the U.S. have always freely exchanged money--but Mundell saw things differently. In the early 1960s, while working at the International Monetary Fund, Mundell completed several papers outlining his theory of international currency exchange. As a result of his work, "we now know that fixed exchange rates are unstable," says Rogoff. Market pressures inevitably force countries to adopt either floating exchange rates or a common currency. Although Mundell's conclusions seem obvious to most modern economists, in the early 1960s "that kind of research was considered weird and obscure," says Rogoff.

But it was also dead on target. Throughout the 1990s, changes in the technology of trade and communication dramatically increased international capital flow and most Western countries abandoned fixed exchange rates. Even more surprising, 11 European states are well on their way to instituting a common currency following the principles set forth by Mundell 4 decades earlier.

"He was far ahead of his time," says Kenen, "he anticipated much of the 1990s economy." Kenen adds that Mundell "didn't have all the answers, but he asked all the right questions." And almost 40 years later, the framework he developed "is still a workhorse of modern international macroeconomics," says Kenen, "it's a remarkable achievement."

Posted in Economics