PARIS — The winner of this year’s Nobel Prize in economics, Edmund Phelps, is a giant in the field. His contributions have been, and remain, so important that they have altered traditional ways of thinking.
According to the social science citations index, he ranks well among the most important economists since Adam Smith. Economists working on the macro-economy, its micro-foundations, exogenous and endogenous growth theory, the formation of expectations and problems of information and discrimination all refer to Phelps.
After a brilliant secondary education, Phelps entered Amherst College in Massachusetts without a specific idea about what discipline to embrace or which career to follow. He was passionate about philosophy but, at the insistence of his father, took classes in economics.
As nearly always happens, Phelps’ choice of vocation came after meeting an important professor, in this case the Harvard economist James Nelson. After some hesitation, Phelps decided to pursue graduate education.
Paul Samuelson admits that he agreed to do a conference at Amherst with the sole aim of recruiting Phelps to MIT. But Phelps chose Yale, where he came into direct contact with James Tobin and Thomas Schelling. He wrote his thesis under Tobin’s supervision.
With Ph.D. in hand, Phelps spent a year at the Rand Corporation in Los Angeles before returning to Yale. He spent another year at MIT, where he taught with Robert Solow and met Samuelson and Franco Modigliani. Stints at the University of Pennsylvania and Columbia University followed.
By this point, Phelps had already acquired an international reputation through his work on the golden rule of capital accumulation (he was 28). This concept now appears in the toolbox of every economist, is taught in all classes on growth, and serves as a reference in all works on the macro-economy.
Later, Phelps developed a long-term growth theory based on education and technical advances. However, this contribution was so far ahead of its time that the profession did not discover its importance until a quarter-century later, when theorists were developing endogenous growth theories.
Phelps was also 10 to 20 years ahead of the profession when he developed the theories of wage efficiency and inflation targeting, which are now considered to be the state of the art concerning the labor market and monetary management.
In the late 1960s and early 1970s, Phelps’ encounters with Amartya Sen, John Rawls and Kenneth Arrow at Stanford revived his philosophical streak. He had extremely valuable intellectual conversations with Rawls, prompting him to write several essays on the theory of economic justice and publish a book on the subject in 1974 — a book still used today.
Phelps was behind the modern reworking of the macro-economy — and, according to Samuelson, the micro-economy, too. His research program consisted of introducing the imperfection of information and knowledge into economic theory, which he then reformulated, giving serious consideration to agents’ expectations. In “Microeconomic Foundations of Employment and Inflation Theory,” a famous work that he published and to which he made three major contributions, he set the scene for what would become the greatest revolution in economic theory of the last 50 years.
It is to Phelps that we owe the theory of the natural unemployment rate — a cornerstone of modern macro-economic theory and economic policy that Milton Friedman rediscovered a year later, albeit heuristically. Phelps was also responsible for the “island parable,” which helped explain why monetary policy can have temporary real effects as a result of imperfect information.
The bulk of Phelps’ current work consists of a new reworking of structuralist theory, in an effort to show how changes in interest rates and asset prices affect the equilibrium unemployment rate over the medium term. Phelps’ new theory provides a logical backdrop against which we can assess the consequences of fluctuations in share prices, exchange rates and, more generally, the value of physical assets and human capital under the powerful influence of new technologies and innovation.
These are, of course, the main phenomena that economic theory struggles to explain nowadays. So it is easy to understand why Phelps still leads the way. Indeed, we can expect his new theoretical framework to become a reference point in a decade or two.
When recommending an Indian mathematician to a Harvard colleague, Ludwig Wittgenstein wrote that “scientific geniuses generally have one great idea in their life; he has had two.” What could we say about Phelps?
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