Expecting the Unexpected: An Interview With Edmund Phelps

In 2006, the Royal Swedish Academy of Sciences awarded the Nobel Memorial Prize in Economic Sciences to Edmund Phelps "for his analysis of intertemporal tradeoffs in macroeconomic policy." Phelps showed that, contrary to the original Phillips curve, there is no long-run trade-off between inflation and unemployment, only a short-term one. Translated into lay speech: You can fool some of the people some of the time and reduce unemployment by paying workers what looks like a higher wage. Eventually, they wise up to the fact that their higher nominal wage is a function of higher inflation, not a higher real wage. Unemployment reverts to its so-called natural rate.

Phelps is the director of Columbia University's Center on Capitalism and Society. I talked with him over the phone on Jan. 25 and Feb. 4 about his views on rational expectations: the notion that people's expectations of economic outcomes are generally right and policy makers can't outsmart the public.