Phelps lends his two cents on savings, unemployment

Nobel Prize winner Edmund Phelps GRD ’59, formerly a Yale Economics professor working with the Cowles Foundation, spoke to the News about his influence on macroeconomics. Phelps is renowned for developing of the theory of the golden rule savings rate, bridging the gap between micro- and macroeconomics and discovering the reasons behind persistent high unemployment in European economies. The News asked Phelps about his time at Yale, and how his research relates to current global economic conditions.

Q: Much of the undergraduate community has studied your work, including the Philips curve, in introductory economics courses. What was your involvement with the theory of the Phillips curve?

A: My point was not that the Phillips curve didn’t exist, I thought it existed then, but my point was that there’s a Phillips curve for every expected rate of inflation: Expected inflation rate is one thing is 2 percent and the Phillips curve is something else, with which inflation rate is 3 percent. If you have a high-pressure policy of boosting aggregate demand to boost employment, then you don’t just ride up the economy to a position higher employment and a higher inflation rate; expectations of higher inflation will kick in. The Phillips curve itself will begin to shift. It’s like shifting sand under your feet. Higher and higher inflation rates corresponding to higher and higher Phillips curves. Basically I pretty much destroyed the idea of the fixed, stable Phillips curve.

Q: Given U.S. expenditures in the wars in Afghanistan and Iraq, are we saving as much as we should be? How does this relate to your work on the golden rule rate of savings?

A: The golden rule idea really was that under certain assumptions, savings-to-income ratio didn’t correspond to the highest possible consumption-savings ratio: higher or lower will correspond to some lower consumption. The idea was really more of a warning against oversaving, rather than undersaving, because later you won’t have enough to consume. People didn’t understand if you always oversave now and also in the future, you won’t gain from higher consumption, because on one hand output will be higher in the future, but you’ll be consuming a smaller proportion of that output when you save.

Q: What about European savings?

A: This takes it outside the golden rule. I think that Europe is wallowing in private wealth, and as a result, there’s been some dilution of normal human incentives to get a job and some money. People think, well, I’ll do that tomorrow because they’re very well supported by the grandmother and the grandfather. They probably all inherited money before that, so I think that one of Europe’s many problems is that people have gotten themselves into a situation of too much security, because they don’t want to take any risks.

Q: What is hysteresis and the higher natural unemployment rate?

A: A lot of it depends on how much dynamism there is in the economy. The countries that have a lot of economic boundaries tend to be very busy. More people employed [in] finance, in marketing, more smiles on people’s faces at the end of the day, low natural unemployment people smile more when you have lower natural unemployment rates. France and to some extent Germany would be an example of economies that are not very dynamic and have somewhat high natural unemployment rates. It can wobble around a bit.

Q: Aside from the U.S., what is an example of an innovative economy?

A: Well, Canada. Another would be South Korea. Another one would be Singapore, although it’s a counter-example of almost everything I believe in. But you’ve gotta admit they’ve pulled off a pretty good trick.

Q: What was your logic in moving from Yale to Columbia? A more prestigious chair?

A: No, what happened to me at Yale was, it had just grown to a colossal size, and the president at the time, Whitney Griswold blew the whistle and said no more economists in tenured positions. No more giving tenure — only younger people. His timing was very bad because he should have blown the whistle 10 years earlier, and he let in a lot of people that were never heard of since. And then when he blew the whistle he missed out on two or three people who would have made a difference.