Edward C. Prescott, 81, dies; Won Nobel Prize for studying business cycles

Edward C. Prescott, whose work explaining the economic shocks of the 1970s inspired new ways of thinking about fiscal and monetary policy, a breakthrough that earned him the Nobel Prize in Economics, died on 6/11 at a nursing home in Paradise Valley, Arizona. He was 81.

His son Ned Prescott said the cause was cancer.

DR Prescott was a leading member of the generation of economic thinkers who, in the 1970s, faced the collapse of the Keynesian models that had dominated policy making since the 1930s but proved unable to cope with the high inflation and low growth of the world economy decade to explain.

Keynesian economics focuses largely on demand, changes in which it is argued lead to fluctuations in the business cycle. But dr Prescott, who worked with frequent collaborator Finn Kydland, asked whether the supply side – like energy costs and particularly technological advances – could be just as important, if not more so.

In fact, their work showed, particularly in a seminal 1982 paper, that supply-side shifts explained the vast majority of changes in the business cycle since the end of World War II. Her research helped spark decades of policy action, beginning under President Ronald Reagan, aimed at reducing taxes and regulations to maximize supply-side efficiencies.

John Maynard Keynes himself might have agreed: as he once said: “Practical men who think themselves totally free from all intellectual influence are usually the slaves of a deceased economist.”

And to be fair, Keynes didn’t have the advanced computer modeling systems that Dr. Prescott’s work possible, and that gave him and Dr. Kydland’s perspective on the economy as a dynamic system.

This understanding of dynamics related to her second critical insight regarding what economists call time inconsistency. As they explained in a 1977 paper, politicians tend to set long-term strategies and goals, but then undercut them for short-term expediency.

They cited public flood insurance as an example. A government might declare that an area is too risky to build on and refuse to insure it. But once people start building there, the politicians will likely cave in to pressure from the voters — and in fact, people will build because they expect the politicians to cave in.

This credibility issue was particularly problematic for Dr. Prescott and Dr. Kydland when it came to central banks. Bank directors may make low inflation their primary long-term goal. But if they face political pressure, they are likely to shift their priorities to higher employment, even if it means higher inflation.

Therefore dr. Prescott argued governments should set long-term rules and stick to them – for example, by isolating central banks from political pressures and setting multiannual budgets.

Both insights came in the late 1970s. DR. Prescott returned to the public eye in 2004, the same year he received the Nobel Prize, with a paper examining why Americans worked longer hours than Europeans.

Unlike other economists who offered explanations that focused on cultural differences, Dr. Prescott argued that it was all about taxes and he offered empirical data to prove it. In the 1950s, when taxes were lower in France than in the United States, French workers worked longer hours than Americans.

But that reversed over the coming decades as tax rates rose in France and fell in the United States. This realization prompted Dr. Prescott to sign a letter with 367 other economists criticizing a proposal by Senator John Kerry, the 2004 Democratic presidential nominee, to reverse tax cuts for high-income people.

“The idea that you can raise taxes and boost the economy is bloody stupid,” said Dr. Prescott told reporters.

For her work, Dr. Prescott and Dr. Kydland shared the 2004 Nobel Prize.

“They offered a new and working paradigm for macroeconomic analysis based on microeconomic foundations,” the Nobel Committee wrote. “Kydland and Prescott’s work transformed academic research in economics and the practice of macroeconomic analysis and policy making.”

Edward Christian Prescott was born on November 12, 1940 in Glens Falls, NY, a town on the Hudson River north of Albany. His interest in economics arose early after watching his father, William Prescott, an industrial engineer, oversee the factory operations. His mother, Mathilde (Helwig) Prescott, was a librarian and housewife.

Edward played football in high school and college despite being of slight physical build, and spent the summers working as a golf caddy and at a nearby paper mill.

He entered Swarthmore College planning to study physics on the way to a career in rocket science, but he saw the school’s faculty as insufficiently theoretical. He switched to mathematics and received his doctorate in 1963.

He received a master’s degree in operations research from Case Institute of Technology in Cleveland, which a few years later merged with Western Reserve University, and a doctorate in economics from Carnegie Institute of Technology in 1967, the same year that the school merged the Mellon Institute to form Carnegie Mellon University.

He married Janet Dale Simpson in 1965. She survives him with her son Ned, as does her daughter Wynn Prescott; another son, Andrew; his brother, William Prescott; his sister Prudence Robertson; and six grandchildren.

Dr. Prescott taught at the University of Pennsylvania, Carnegie Mellon and the University of Minnesota before moving to Arizona State University in 2003. In 1981 he became an advisor to the Federal Reserve Bank of Minneapolis.

At one point, he almost accepted a job at the University of Chicago, but decided against it because his son Ned was a graduate student in the university’s business school and he didn’t want to risk a conflict of interest. Ned Prescott now works for the Cleveland Fed.

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