Monday, October 11, 2004

Norwegian, American share Nobel economics prize - Oct. 11, 2004

Norwegian, American share Nobel economics prize - Oct. 11, 2004

Congratulations to Finn Kydland and Edward Prescott on winning the 2004 Nobel Prize for Economics!

While economic forecasting is difficult, our understanding has improved greatly in recent decades. We have come to understand that monetary and fiscal policy are important and that the supply side (not just the demand side) must be considered. These insights are in no small part because of Kydland and Prescott.

In any Macro Economics class or Money and Banking class it is now standard fare that supply shocks matter. For instance, the economy soared in the 1990s in part because of the increased technology that was available. Kydland and Prescott were at the forefront of this economic revelation when in 1982 "they created a model which showed that supply-side shocks -- such as technology -- are a driving force behind the business cycle, rather than variations in demand alone." (CNN)

Their famous 1982 Econometrica paper also showed the importance of expectations on the business cycle. For instance, if higher inflation is expected, but not here yet, market participant's will act as if it is there. This was particularly important during the 1970s when central bankers continually changed their policies designed to keep the inflation in check. Predictably, these changes often led to higher inflation. From the San Francisco Chronicle:

"In the 1970s, many Western countries had high inflation because their central
banks didn't keep a consistent monetary policy. They accepted rising inflation
for a short-term decrease in unemployment, said Per Krusell, a member of the
Nobel Committee for Economics. A 1977 article by Prescott and Kydland
highlighted this problem, which led to many countries forcing their central
banks to stick to certain policies, regardless of market forces."

Kydland teaches at Carnegie Mellon University and the University of California. According to the SF Chronicle he was teaching when he herd he had won:
"Kydland told The Associated Press he learned about the prize during a lecture
at the Norwegian School of Economics and Business Administration in Bergen,
Norway. "I was a little perturbed when they interrupted my lecture until I got
to the secretary's office and found out what the phone call was about,"

Prescott teaches at Arizona State. No reports as to what he was doing when he heard.

Overall a very good choice! FWIW I still think Jensen and Fama are deserving of the award. Maybe next year!

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