Conventional wisdom used to be that over the long run, a drop in the unemployment rate comes at the price of more inflation. The so-called Phillips curve said there can be low unemployment or low inflation, but not both. As a young economist in the 1960s, Edmund S. Phelps ’55 challenged the prevailing view that unemployment could be lowered in the long run. He threw away the textbook, showing that in the long term, the apparent trade-off between unemployment and inflation does not exist. Today, the model he developed is a standard policy and research tool.
Now the work has earned Phelps, the McVickar Professor of Political Economy at Columbia University, this year’s Nobel Prize in economics. “He recognized that inflation does not only depend on unemployment,” said the Royal Swedish Academy of Sciences, which awards the prize, “but also on the expectations of firms and employees about price and wage increases.”
Periods of low unemployment, explains Geoffrey Woglom, the Richard S. Volpert ’56 Professor of Economics at Amherst, occur before workers and firms realize that prices and wages are rising faster than they thought. “As soon as they adjust their expectations,” Woglom says, “unemployment goes back to the natural rate.” Woglom has never met Phelps, but teaches his work in the classroom. Woglom says that Phelps, as well as economist Milton Friedman, who was working independently on these issues, laid the groundwork for the New Classical revolution in the 1970s that fundamentally changed the way economists analyze government stabilization policies. (Friedman won the Nobel in economics in 1976.)
Phelps got the good news just after 6 a.m. on October 9, when he awoke to a phone call from Sweden. “I thought for a time I would get it in my 60s, then I thought I would get it in my 70s and, more recently, I’ve been thinking that I would get it in my 80s,” Phelps, who is 73, said at a press conference that day. He later spoke by e-mail to Amherst about why he first questioned the Phillips curve: “The curve was simply postulated. It lacked any theoretical basis. It had nothing to do with monetary and fiscal stimulus.”
At Amherst, Phelps studied economics under the late professors James Nelson and Arnold Collery. “I liked the difficulty of the subject—plenty of unsolved questions,” says the Nobel laureate.
Phelps is also known for earlier work about savings and consumption, according to Woglom. The standard analysis used to be that when society saves more money, the immediate impact is a lower rate of consumption, but that income eventually grows to increase consumption in the long run. Phelps, however, argued that increasing the savings rate too much could lower consumption both now and in the future.
Phelps is the fourth Amherst alumnus to win a Nobel Prize. The others are Joseph E. Stiglitz ’64 (Economics, 2001), Harold E. Varmus ’61 (Medicine, 1989) and Henry W. Kendall ’50 (Physics, 1990).
Phelps spent his first day as a Nobel laureate giving a press conference and live TV interviews. “My wife and I were way too exhausted to celebrate that evening,” he says. “There are plenty of celebrations coming up for weeks and months.”