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Two Share Nobel in Economics

Researchers' Theories on Business Cycles Influence Monetary Policies

By Nell Henderson
Washington Post Staff Writer
Tuesday, October 12, 2004; Page E01

Two economists known for their globally influential work on the forces behind economic booms and busts have won this year's Nobel Prize in economics, the Royal Swedish Academy of Sciences announced yesterday.

American Edward C. Prescott, 63, a senior monetary adviser at the Federal Reserve Bank of Minneapolis and a professor at Arizona State University, and Finn E. Kydland, 61, a Norwegian-born professor at Carnegie Mellon University, will share the $1.4 million prize, said the academy, which selects the Nobel Prize winners.

Edward C. Prescott, a professor at Arizona State University, focused on the causes of depressions and how nations increase productivity. (Matt York -- AP)

_____Related Coverage_____
Excerpts From Nobel Economics Citation (Associated Press, Oct 11, 2004)
Recent Winners of Nobel in Economics (Associated Press, Oct 11, 2004)
Winners at a Glance
Video: An American and a Norwegian won the 2004 Nobel prize in economics Monday for their work in determining the driving force behind business cycles worldwide.

Prescott and Kydland collaborated on two key papers, published in 1977 and 1982, that focused on closely related issues. One was on the causes of "business cycles," or the economy's growth over time through a succession of expansions, recessions and recoveries. They showed how these cycles result from the collective decisions of consumers, businesses and economic policymakers, as well as advances in technology.

The second focused on the design of economic policy -- specifically the crafting of monetary policy to control inflation and influence economic growth through raising and lowering interest rates, and the shaping of fiscal policy to affect growth through federal government tax and spending decisions.

Prescott and Kydland showed that when government policymakers pursue stated goals inconsistently, it hurts their credibility with the public and can cause businesses and consumers to behave in ways contrary to those goals.

A central bank, for example, may say it is seeking to limit inflation but pursue policies that cause borrowers to expect that prices will rise. They are then likely to act on those expectations in ways that actually fuel price increases -- as happened in the United States in the 1970s.

Partly in response to such work, Federal Reserve policymakers have put a premium on managing expectations about inflation by constantly reaffirming their determination not to let inflation out of control. They do not want a false perception of Fed complacency to feed fears of rising prices, thus encouraging businesses to raise prices and workers to demand higher wages.

Prescott's and Kydland's work has "not only transformed academic research in economics, but has also profoundly influenced the practice of economic policy in general, and monetary policy in particular," the Swedish academy said in a statement.

The two men have worked closely together on and off for years. Both earned their PhDs in economics at Carnegie Mellon.

Prescott's research has focused on what causes economic depressions, why some countries thrive economically while others stagnate, and how nations boost productivity, or output per labor hour.

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