Economist Wins Nobel Prize for Describing Key Roles of Long-Term Expectations by Employers and Workers

By DAVID GLENN

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Edmund S. Phelps, a professor of political economy at Columbia University, will receive this year's Nobel Memorial Prize in Economic Science for his insights about how long-term expectations shape national economic conditions, the Nobel Foundation announced this morning.

In three papers written from 1967 to 1970, Mr. Phelps transformed the standard understanding of the trade-off between unemployment and inflation. During much of the 1960s, influenced by what is known as the Phillips Curve, policy makers had assumed that there was a simple, static tension between the two phenomena: If many people had jobs and the labor market became tight, inflation would be the natural result.

Mr. Phelps's late-1960s insights complicated that picture. In a series of formal models, he described an economy in which inflation is caused both by unemployment and by business owners' and workers' expectations of future inflation. If high inflation is built into economic actors' expectations, he suggested, that can produce a destructive spiral in which price increases accelerate even further.

Instead of looking at short-term trade-offs between unemployment and prices, Mr. Phelps argued, policy makers should concentrate on steering the economy toward employment levels that are optimal and sustainable over the long term. In practice, that advice has been taken to mean that governments should aim for consistently low levels of inflation.

Mr. Phelps has also done influential work on how long-term expectations affect wages at the level of individual businesses. He was among the first scholars to present a formal model of "efficiency wages" -- that is, situations in which businesses might rationally choose to pay wages that are somewhat higher than are necessary to fill their job vacancies, in order to reduce turnover and improve employee morale.

In a 1972 book, he suggested that large spikes in unemployment might have irreversible destructive consequences, as workers' skills and morale deteriorated while they sat at home. Just as inflation can have cancerous effects on business owners' long-term expectations, he suggested, unemployment can have poisonous effects on workers' long-term hopes.

More recently, Mr. Phelps has put forward an idiosyncratic public-policy proposal: He would like the federal government to provide tax subsidies to businesses that hire low-wage workers. His idea is to raise wages for low-skilled workers just high enough that many more of them will be interested in taking jobs.

In Rewarding Work: How to Restore Participation and Self-Support to Free Enterprise (Harvard University Press, 1997), he argued that his proposed subsidies would make labor markets tighter and would have wide-ranging social benefits, including reduced crime. "The subsidies would have the 'multiplier effect,'" he wrote, "of alleviating the pessimism and poor preparation that tend to spread like a contagion in poor communities."

In an interview with The Chronicle in 2003, Mr. Phelps explained one reason why he believes that the federal subsidies should be paid to employers, rather than being given directly to low-wage workers, as in the Earned Income Tax Credit. "It's better for the worker to see the total compensation coming from the firm," he said. "I think that adds to self-respect if the worker is not constantly reminded that you're in a special program -- that, look, you're a low-productivity guy and that's why your employer is only paying you nickels and dimes" (The Chronicle, January 16, 2004).

Mr. Phelps was born in 1933 and earned his doctorate at Yale University. He has taught at Columbia since 1971.

There are now three Nobel winners on Columbia's economics faculty. Mr. Phelps joins Robert A. Mundell, who won the prize in 1999, and Joseph E. Stiglitz, who won in 2001.

The economics prize, which is formally known as the Bank of Sweden Prize in Economic Sciences in Memory of Alfred Nobel, was not one of the five awards set up by the will of the Swedish scientist. The prize was established in Mr. Nobel's honor in 1968 by the Bank of Sweden.

The award is worth approximately $1.4-million; the prize will be formally presented at a ceremony in Stockholm on December 10.

More information about the prize winner is available on the Nobel Web site.

Other news of the 2006 Nobel Prizes:

• Freeze-Frame Photos of Key Process in Cell DNA Win Nobel Prize in Chemistry for Stanford Researcher (10/4/2006)

• Nobel Prize in Physics Awarded to 2 American Cosmologists for Findings on Universe's Infancy (10/3/2006)

• Nobel Prize Goes to 2 Americans for Discovery of Key Control of Cell's Genetic Workings (10/2/2006)