Kydland has done work on international trade and on how the money supply, or the availability of credit in an advanced economy, affects the business cycle.
Their work "reshaped the way all economists think," Kenneth B. Dunn, dean of Carnegie Mellon's business school, said in a statement.
Edward C. Prescott, a professor at Arizona State University, focused on the causes of depressions and how nations increase productivity.
(Matt York -- AP)
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.
"Ed has revolutionized the way we do macroeconomics -- here at the Minneapolis Fed and at universities across the globe," Ellen R. McGrattan, a senior economist at the bank, said in a statement. "In recent work, Ed asks, 'Why are Americans working much more than Europeans?' His answer is lower [U.S.] taxes. When I think about the many hours that Ed spends in his office, in the classroom and with his graduate students, I know the answer in his case is not lower taxes. It is his love of the science."
Neither professor responded to e-mails requesting comment. Kydland was teaching in Norway yesterday at the Norwegian School of Economics and Business Administration when an assistant interrupted the lecture to tell him he had won the prize, Bloomberg News reported. Prescott did not respond to a request by telephone for comment.
The two researchers' work was part of efforts throughout the economics profession in recent decades to explain the puzzle of the "stagflation" that beset the U.S. economy in the 1970s, when economic growth stagnated amid double-digit inflation and interest rates. That confounded the belief at the time that there was a trade-off between inflation and growth and that allowing inflation to rise a bit would enable unemployment to fall and growth to pick up.
Until the 1970s, the experience of the Great Depression and the work of economist John Maynard Keynes had led economists to see business cycles as essentially driven by rising and falling demand -- consumers' demand for goods and services and businesses' demand for labor, raw materials, equipment and other "inputs" used to produce goods and services. When demand slumped, so did economic growth and employment; when demand surged, so did growth and employment.
Consequently, most discussion of economic policy had focused on how to offset big swings in demand. The Fed, for example, would raise interest rates to fight inflation during a boom or lower them to spur spending during a recession. Or the federal government would increase spending or cut taxes to boost growth during a slump.
But the economic turmoil of the 1970s led to a rethinking of the old models. Many economists agree that the problems resulted from a combination of several events and policy mistakes, including fiscal policies during the Vietnam War that led the economy to overheat, monetary policies that allowed inflation and inflation expectations to take off, oil price hikes, and a sharp slowdown in productivity growth.
Prescott and Kydland made key contributions to this understanding first by showing that policy inconsistency can contribute to economic troubles. In the 1970s, for example, the Fed tightened and eased the availability of credit at various times, to combat inflation and slumps, but failed to thwart either. On the contrary, the Fed's mistakes made matters worse.
The two researchers also showed, importantly, that the strength of economic growth reflects changes not just in demand, but also in the supply of labor, materials and equipment, and particularly advances in technology. New technology can fuel growth by enabling business to operate more efficiently. Increasing productivity allows living standards to rise as businesses become more profitable and traditionally share a portion of the proceeds with workers and shareholders. Wages, stock prices and dividends can rise without driving up prices.
Prescott and Kydland's papers were written decades ago, but their observations were borne out in the late 1990s, when the economy boomed amid a spectacular gain in productivity attributed to advances in information technology.
Alfred Nobel, the Swede who invented dynamite, established the Nobel prizes for achievements in physics, chemistry, medicine, literature and peace through his will in 1896. The economics prize was created by the Bank of Sweden in 1968 in his memory.