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October 15, 2006
David Warsh, Proprietor

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The Realist

When economists gathered in 2001 at Columbia University to honor Edmund Phelps with a festschrift, it was a celebratory conference. The truly remarkable thing was the temperamental diversity of the cast of characters. Paul Samuelson gave the opening talk. Robert Lucas presided over one series of papers, Robert Solow over another. Thomas Sargent and Michael Woodford contributed; so did Olivier Blanchard, James Heckman, Robert Hall, Joseph Stiglitz, N. Gregory Mankiw, Steve Nickell, Jean-Paul Fitoussi, Daron Acemoglu and Charles Jones.

For a couple of days then, the scene on Morningside Heights resembled those famous Edward Hicks paintings of “The Peaceable Kingdom”, wolf and lamb, leopard and goat, calf and lion, colonials and native Americans, side by side at noble ease, and, in the center of it all, instead of a young child, Ned Phelps.

It was a rich reward for a scholar who hadn’t reached the public pinnacle of the profession, and might never.  After all, Robert Lucas had been honored six years earlier with a Nobel Prize for work that built on Phelps’ great papers. A full quarter century before, Milton Friedman had been honored with a Nobel for, among other things, his “demonstration of the complexity of stabilization policy” — a critique of the reigning dogma nearly identical to one that Phelps had made a few months earlier, but which, unlike that of Phelps, offered no apparatus to put in that dogma’s place.

Last week the Swedes made good on the lapse in their narrative, and the world was introduced at last to both a master economist and to a controversy long resolved, to good effect. Phelps, 73, who obtained his PhD from Yale in 1959, started working immediately at a high level, and has never stopped.

The Nobel committee cited him for the hard scientific work in the late 1960s and early 1970s that was necessary to pin down and communicate the central insight that he and then Friedman had broached within a few months of one another in 1967 and 1968 — that easy money would have, at best, only a temporary effect on unemployment, and that in fact there was a “natural rate” of unemployment in any economy that could be addressed only by more fundamental measures.

In the 1960s, the Keynesian orthodoxy celebrated as the “new economics” was dominated by the empirical regularity known as the Phillips Curve — the relationship between inflation and the unemployment rates, first observed by New Zealand economist A.W. Phillips, and subsequently nominated by Samuelson and Solow in 1960 as the basis for a plausible policy — accept slightly higher rates of inflation in order to reduce unemployment.

In contrast, Phelps deployed a series of original and carefully-reasoned models of individual decision-making, arguing that successive doses of inflation would lose their effectiveness once they were incorporated into expectations. He sought to ground his explanation of the lofty macroeconomic variable — output, inflation, unemployment — in the analysis of wage-setting and spending decisions of firms and households, a decisive step in the direction of greater realism.

(In one famous model, he conjured up a series of islands to represent the plight of investors and workers possessing very different sets of information and expectations of the state of the economy. “The actors of [our] model have to cope ignorant of the future and even much of the present. Isolated and apprehensive, these Pinteresque figures construct expectations of the state of the economyÉ and maximize relative to that imagined world.”)

In a retrospective essay some years ago, Phelps wrote: “It might be thought that the late 1960s modeling of the Phillips curve and, as a byproduct, the natural rate of unemployment, grew out of great agitation and yearning for light.

“In fact, the Keynes-Phillips orthodoxy was sailing on smooth waters, the object of much congratulation, rather like the liner Titanic prior to its collision with the fateful iceberg.”  Instead, he wrote, his inspiration had its origin in deep cogitation during the summer he spent in Cambridge, England, in 1966, and during his first few months that fall as a newly minted professor at the University of Pennsylvania.

“Man is a thinking, expectant being!” Phelps wrote many years later, recalling his train of thought at the time. “What was needed was a model of a sequence:  the firm’s expectations, its subsequent actions and those of the others, the discovery of the others’ actions, the formation of new expectations, and so forth.”

A great commotion then ensued with defenders of the dominant Keynesian orthodoxy, from which Phelps and many others eventually emerged, not so much disillusioned as, rather, born-again “new Keynesians,” Much of that action took place at Penn.  It was there in January 1969 that Phelps convened an informal conference (with the backing of the National Science Foundation’s James Blackman and publisher Donald Lamm) that appeared a year later as Microeconomic Foundations of Employment and Inflation Theory – the “Phelps volume,” as it quickly became known.  And for the next few years, the construction of coherent micro foundations for Keynesian macroeconomics was all the rage.

When the shouting subsided, many of the intellectual landmarks of the present age had been created. Robert Lucas had installed the idea of forward-looking rational expectations at the center of monetary policy. Edward Prescott and Finn Kydland had shown that the decision-making process of monetary authorities was best understood as a strategic game involving credibility and commitment. Guillermo Calvo and John Taylor had begun their work on targets, rules and transparency. The path to the present-day understanding of monetary policy was clear. Central banks were no longer expected to manage the unemployment rate.

Philippe Aghion, a Harvard professor who advocated a Nobel award to Phelps as powerfully as anyone, thinks that logically the prize should have been given jointly with Lucas in 1996. Maybe so; maybe not: there is an intensely personal quality to Phelps’ work that is the polar opposite of Lucas’s.  Nowhere is that more conspicuously or attractively on display than in Phelps introductory textbook, Political Economy, which appeared in 1985. Deemed too demanding for all but the brightest students, the book ranged widely over the history of thought, from game theory to the philosophy of justice, from Marx to Keynes –and featured a quotation from classic films at the top of every chapter.  

The Nobel citation last week dwelt on a second skein of Phelps’ work, his earliest work, on capital accumulation, especially a paper published in 1961 under the whimsical title “The Golden Rule of Accumulation: A Fable for Growthmen.” Several other economists reached similar conclusions at more or less the same time, and Phelps later wrote “Within a few short years [of entering the profession] I became an internationally known economist.  Yet I came to feel that I was simply winning (or losing) foot-races by a few steps.  I saw that if I was to do anything of unusual depth or distinctiveness I would have to think much harder than I had generally done — to raise the level of my game.”

In the next few years, that is exactly what he did.  “There is, as I was to appreciate better, a big difference between scanning existing models for their unnoticed implications, on the one hand, and, on the other, acquiring an independent empirical sense of some overlooked or misunderstood way the economy works.”

Ned Phelps will give the prize lecture in economics in Stockholm on December 8.

(The long wait for a call from Stockholm that might never come insured that there would be an abundance of material on Phelps’ career available, regardless of whether it did or not. The proceedings of the 2001 Festschrift are collected in a fat paperback: Knowledge, Information and Expectations in Modern Macroeconomics, edited by Philippe Aghion, Roman Frydman, Joseph Stiglitz and Michael Woodford.  A beguiling autobiographical essay can be found on Phelps’ website (, as well as a retrospective essay on the evolution of the idea of the natural rate of unemployment.)

* * *

Harvard University’s administration has quietly concluded its deliberations in the Andrei Shleifer matter, stripping him of his endowed chair but otherwise making no public finding.

Shleifer said the case against him for his stewardship of Harvard’s failed Russia project is finally closed.

Interim dean Jeremy Knowles last week told the Harvard Crimson that “appropriate action” had been taken and communicated to Shleifer, but didn’t say what it was, citing privacy concerns.

Shleifer emailed the student newspaper from Amsterdam, where he was giving a lecture, “I am delighted that this matter is full behind me. I look forward to following [Knowles] advice and focusing my energies fully on scholarship, teaching, and on service to economics and to Harvard.”

The Boston Globe reported the next day that the university’s web page no longer identified Shleifer as the Whipple VanNess Jones professor of economics. The rank had been conferred on him in 2002 by then-Dean Knowles, not long after the US government had charged him and the university itself with fraud in the conduct of the advisory team he led in Russia. “I was a professor of economics last week, and I am a professor of economics this week,” Shleifer told the Globe’s Marcella Bombardieri Friday.

A seven-member faculty Committee on Professional Conduct forwarded a report on the affair to Knowles last summer.  Crimson reporter Javier Hernandez wrote last week that “Several committee members are upset with the dean’s management of the issue and some have questioned whether the case was handled fairly, according to two individuals who have spoken with professors on the committee.”

The way is finally cleared for Shleifer to publish the defense of his actions that he has promised his supporters.

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