In October 2004, Edward C. Prescott, an adviser at the Minneapolis Fed since 1981, received his profession's highest honor, the Nobel prize in economic science. Prescott and his collaborator Finn Kydland were jointly recognized by the Royal Swedish Academy of Sciences for "fundamental contributions to the research area known as macroeconomics. In a highly innovative way, the Laureates have analyzed the design of economic policy and the driving forces behind business cycles."
The Academy cited two papers in particular. In a landmark article published in 1977, Kydland and Prescott described the problem of time-inconsistent policy—the inherent tendency of policymakers to change policy over time, the public's ability to anticipate such change and the resulting ineffectiveness of policy. Because of time-inconsistent policy, they showed, efforts to spur the economy can actually have the opposite effect and be inflationary as well. Their theory explained the "stagflation" of the 1970s and helped shape the Federal Reserve's policy, since Paul Volcker became chairman in 1979, of solid commitment to price stability.
In 1982 the two published another key article, which showed that sudden changes in supply—not demand, as conventionally thought—could account for short-term economic fluctuations. According to their research, technological innovations or sudden oil-price spikes could explain more about business cycle variation than could shifts in consumer spending or government expenditure.
These theoretical breakthroughs, observed the Swedish Academy, have had a deep impact on both academics and policymakers. "Their work has not only transformed economic research, but has also profoundly influenced the practice of economic policy in general, and monetary policy in particular," said the Nobel statement. Central banks around the world, for example, have sought full independence from political influence so as to avoid time-inconsistent monetary policy and its inherent inflationary bias.
A day after receiving the early morning call from Stockholm, Prescott flew to Minneapolis from Arizona State University, where he now teaches half the year. "I'm deeply honored to receive this award," he told colleagues. "As research economists we love our work. We do it regardless of public recognition. But the truth is, winning the Nobel is wonderful, a much bigger deal than I ever imagined."
Prescott began work at the Minneapolis Fed after joining the economics department at the University of Minnesota 23 years ago. In addition to work on time inconsistency and business cycle theory, he has done pioneering research in econometric methodology, economic development, finance economics and general equilibrium theory, among other areas.
As reflected in his role as the Minneapolis Fed's senior monetary adviser, much of Prescott's work has direct application to monetary theory and practice. "It is a privilege to have Ed on staff here," said Gary Stern, president of the Minneapolis Fed. "His research and counsel have been of immeasurable value to us over the years, and I'm deeply pleased that his profound contributions to economic theory and policy have been recognized by this award."
Prescott returned the praise. "The Fed is a fabulous place to be," he said. "We get interesting problems thrown at us every day, and we're just tremendously excited about working on them."
Prescott's Nobel is a capstone in a career marked by many honors, including a Guggenheim in 1974-75, fellowship in the Econometric Society in 1980 and in the American Academy of Arts and Sciences in 1992, and the Erwin Plein Nemmers Prize in Economics in 2002. Prescott gives much credit to others for inspiring and supporting him in his research. "My colleagues here in Minnesota and in the broader economics community have been absolutely crucial to my work. This award honors them all."
See more about Prescott and the Nobel prize.