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Episode 31. Edmund Phelps (Nobel Prize Winner and Columbia Economics Professor) on His Career and Contributions To Macroeconomics
Written Interview Transcript
Edmund Phelps (Nobel Prize Winner and Columbia Economics Professor) spoke with Jon on his his academic career and contributions to macroeconomic theory including helping to come up with the ideas for the natural level of unemployment, the Golden Rule savings rate, and sticky wages and prices. The below interview is a written interview and was conducted over email.
Jon: This is the Capitalism and Freedom in the 21st Century Podcast, where we talk about economics, markets, and public policy. I'm Jon Hartley, your host. Today my guest is Edmund Phelps, the winner of the 2006 Nobel Prize in Economics and the Director of the Center on Capitalism and Society at Columbia University. Ned has been a professor of economics at Columbia since 1971, after being a professor at the University of Pennsylvania and Yale. Ned is well known for his contributions to macroeconomic and economic theory including developing the natural level of unemployment, the Golden Rule savings rate, and staggered wage and price setting among many other monumental contributions.
Thanks so much Ned for speaking with us. You’ve had such a long and distinguished career in economics. What got you first interested in economics?
Ned: When I was a student at Amherst, I thought I would major in philosophy, but it was my father who, thinking I would like it, suggested I take an economic course. He was right -- I became engrossed in the brilliant textbook by Samuelson and I was captivated by James Nelson’s witty lectures.
I was drawn to the field in part because of a puzzle I saw in the introductory course: it was not clear to me how microeconomics and macroeconomics might be connected. There seemed to be a disconnect and I had a sense that bridging that gap might make a difference.
Jon: What got you first interested in economic growth and how did your idea for the Golden Rule savings rate come about?
Ned: I published the “Golden Rule of Accumulation” when I was at Yale’s Cowles Foundation. The idea drew on the 1950s growth models of Robert Solow and Trevor Swan and ultimately shows that there can be too much saving.
Perhaps what is most unique about that paper is the style in which it is written: the mathematical model is set in a fictional town (Solovia named after Solow) of people rapt in the excitement of the equations unfolding. I am not sure why I took such an approach, but I imagine it was simply to have a little fun. I recall that Solow, amused, wrote a sequel fable that he never published.
At some point I became restless with the classical character of growth economics and set out on a project in a less classical vein that would become my 1965 book Fiscal Neutrality toward Economic Growth. That book was a first try at thinking about mis-expectations – about economic disequilibrium and its correction.
Jon: Did your interest in business cycles come naturally to you? How did your interest in Phillips curves and your idea on the natural rate of unemployment come about which was co-developed with Milton Friedman?
Ned: My interest in business cycles perhaps dates back to my senior year at Amherst, the autumn of 1954, when Paul Samuelson gave a brilliant visiting lecture on Austrian business cycle theory. Having read and enjoyed his textbook, I was transfixed by his lecture and thrilled that I was chosen to meet with him during that visit and ask for his advice about graduate school.
A few things lead to my interest in employment theory. The most important being that disconnect between micro and macro that I mentioned earlier. While thinking of Frank Knights Risk, Uncertainty and Profit and Keynes’s “sticky wages,” I noticed two things: Knight while offering a departure from neoclassical models in acknowledging the presence of uncertainty, particularly among investors, did not assert that uncertainty could sometimes be a force driving wide swings of employment. And Keynes in his General Theory had offered a theory of employment without offering a theory of wage-setting by firms.
What I did was introduce a formulation of wage behavior that included the expectations of the rate at which wages are changing in the economy as a whole – if these expectations were to adjust slowly, the wage rate would adjust slowly too. While the Phillip’s Curve is essentially a statistical estimate of a mechanistic hypothesis, my theory is microeconomic in that it derives from the conception of decision-making of individual firms – it came to be termed “micro-macro.”
Exploring expectations further lead me to developing a model of a theoretical economy built around price expectations and behavior of that nature which postulated that the rate of inflation depends on the rate of unemployment and the expected rate of inflation. This model featured the “natural rate of unemployment.”
Regarding the natural rate, I should clarify that Milton Friedman and I were not working on the idea of the natural rate together. Rather it was a coincidence that came about in our independent research. What I dubbed the “equilibrium rate of unemployment,” Friedman had dubbed “the natural rate of unemployment.” It just so happened that it was Friedman’s term that stuck.
Jon: How did the idea for staggered wage contracts in your 1977 paper with John Taylor come about? It's been hugely influential in macro and New Keynesian models.
Ned: In the 1970s, I recruited John Taylor to handle econometrics and Guillermo Calvo to handle macroeconomic theory at Columbia. As friends and colleagues we often got together to exchange ideas. I don’t remember off the top of my head how that particular paper came about. However, I recently sent my papers to Duke’s Economics Archives. Included in the lot were many drafts and letters with Taylor that will soon become available to those interested.
Jon: Do you remember the famous feud between Friedman and the Cowles foundation? Were there any things there that you felt were important in the direction of macroeconomic theory? Was Koopmans and Yale a net winner in that fight over Cowles in your mind?
Ned: I have no memories of the feud between Friedman and Cowles. That interaction took place between 1939 and 1955. I was still quite young then.
Jon: How do you feel economic theory is being treated today by a field that has gone very empirical in recent decades? What do you think is missing from economic theory and attitudes toward the economy today?
Ned: I think there is still much to reform. Particularly when it comes to job satisfaction, the nature of work and attitudes toward work. People need an economy that provides them not only with pecuniary rewards but also non-pecuniary rewards. They need work that is interesting and engaging with occasional opportunities to use their creativity, to hit upon and share new ideas with managers. For a good life, they need to feel a sense that they are at times succeeding at something.
Jon: Do you have any thoughts on how economics is now turning away from full information rational expectations to some degree?
Ned: I think this is a necessary development and I would be glad to see economists move away from neoclassical theory and toward something new. I never thought that the rational expectations premise was satisfactory or even clearly preferable to some flexible use of adaptive expectations. With an ever changing-world and economy, the models and tools we use to analyze it must also change.
Jon: You've written several books on dynamism including Mass Flourishing and Dynamism. What do you think about dynamism today?
Ned: My focus is on grassroots innovation – ordinary people, as I call them, participating in the economy, using their imagination to create new products and new methods of production. My indigenous theory differs sharply from Schumpeter’s theory in which innovation is exogenous coming mostly from scientists and navigators outside of the economy.
Western societies are rife with dissatisfaction and despair. For some time I have been pointing to the loss of modern values – mainly individualism (not to be confused with selfishness), vitalism, and the desire for self-expression – as a major cause of the loss of dynamism, thus the slowdown of innovation and economic growth.
This is not to say there is no innovation happening. We've still got a few geniuses out there, some of whom have new ideas of immense commercial value. But we're not going to get anywhere close to the mass of innovation that we had from the 1880s until about 1970 until a more fundamental shift in societal values occurs.
With the vast and ever widening rift between the political left and right, I find it hard to imagine that the needed changes will occur soon.
Jon: Ned, thanks so much for joining us for such a fascinating conversation about your work.
Today, our guest was Edmund Phelps, the winner of the 2006 Nobel Prize in Economics and the Director of the Center on Capitalism and Society at Columbia University.
This is the Capitalism and Freedom in the 21st Century Podcast, where we talk about economics, markets, and public policy. I'm Jon Hartley, your host. Thanks so much for joining us.
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A podcast series of the Hoover Institution’s Economic Policy Working Group hosted by Jon Hartley. The podcast interviews economists, policy makers and practitioners to learn about their thinking featuring discussions on the wide range of economic topics.