An economist who saw his parents suffer the consequences of the Great Depression and went on to correct a fundamental misunderstanding about the relationship between unemployment and inflation has won the 2006 Nobel Prize in Economics.
Edmund Phelps of Columbia University receives the $1.4 million award for two main contributions made over a 4-decade-long career: showing that increased inflation does not reduce unemployment in the long run, and determining the fraction of national income that needs to be saved in order to enable future generations to enjoy the same level of consumption. Both lines of research have had considerable influence on economic policy around the world.
Economists had believed that it was possible to cut down unemployment through policies aimed at expanding the economy--such as printing more money--even though such policies would jack up inflation. Phelps realized that this macroeconomic view was wrong. When there's more money to go around, wages go up, and employees start spending more--leading to short-term boost in jobs--until they realize that prices have also been going up and that they are no better off than they were before. Employees then try to negotiate even higher wages and buy less, causing employment to drop back to earlier levels.
Phelps's work has had a fundamental impact on the way governments shape economic policy, says Guillermo Calvo, an economist at the University of Maryland in College Park who was Phelps's student at Yale and then his colleague at Columbia. "The reason that the U.S. economy was able to grow rapidly in the '90s without there being high inflation was the result of fiscal and monetary policies informed by his work," Calvo says. Phelps's other work has had a similar influence on both economics research as well as policy, he says.
Phelps had an early brush with a macroeconomic phenomenon: His parents lost their jobs in the Great Depression. Phelps spent his teenage years digesting financial and economic news gleaned from newspapers, which he would then discuss at the dinner table. The interest never faded. "He was constantly fishing for ideas, always thinking about scientific issues," says Calvo, recalling his association with Phelps at Columbia. "If you went to him, he would always give you insights that could be used in your own research. And he did this not just because he was a good man but because he was a very committed scientist."