Tribute to Nobel laureate Edward Prescott

Prof Rajnish Mehra of Arizona State University pays tribute to Prof Edward Prescott:

Edward Prescott, co-recipient with Finn Kydland of the 2004 Nobel Memorial Prize in Economic Sciences, passed away in November 2022. This column, written by a long-time friend and co-author, outlines his many research contributions, including being one of the scholars that laid the foundation of the rational expectations revolution in dynamic macroeconomics. He and Kydland were the architects of real business cycle theory and the literature on time inconsistency, which has reshaped our thinking about the credibility of government commitments and had a profound impact on policymaking, particularly monetary policy.

 

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The intersection of academic and real-world economics

Prof Claudia Buch, Vice-President of the Deutsche Bundesbank in this speech discusses the intersction of academic and real world economics:

Let me, first of all, thank the organisers for inviting me to give this talk on the occasion of the launch of the German edition of CORE Econ.[1]

Over the years, I have followed the CORE project very closely as it is based on a concept that is very close to my thinking about economics – and about teaching economics. Let me highlight a few features which I think are particularly relevant – the importance of evidence-based policymaking, of understanding frictions in markets, of linking theory and evidence, and of using case studies.

In developing these arguments, I will use examples from financial stability policies, which is one of my main responsibilities at the Bundesbank. Financial stability is, in short, about the ability of the financial system to perform its functions for the real economy – even in times of stress and structural change.

In the end:

Financial stability policies are all about prevention, about reducing the probability that financial crises will occur, and about reducing the damage done if they do happen. But, typically, we do not fully appreciate the benefits of prevention: we all notice the absence of stability during a crisis, but we’re often unwilling to make the necessary adjustments early on. In this sense, financial stability is subject to the “prevention paradox”, which is a phenomenon that we also know from health policy.

Hence, we need a good understanding of why financial stability matters to us all. Financial crises can be hugely costly in terms of employment and output, and to the taxpayer. Hence, discussing the stability of the financial system, and ways to improve it, is relevant for the general public as well.

Yet, memories of the Great Financial Crisis are fading fast, and many see financial market issues as something that only experts need to consider. A typical economics student may have just started primary school when the Great Financial Crisis erupted in 2007/2008 and have no memories of their own of that episode. This may hold in particular in Germany, where the impact of the Global Financial Crisis in terms of corporate insolvencies or on the labour market was barely felt.

This is where teaching plays an important role. We need a good understanding of how the financial system works. And we need to engage in the broader debate surrounding this whole topic: where should scarce financial resources go to promote growth and innovation? What risks does a society want to take? Who should bear these risks? And what do innovations in the financial sector deliver for customers in terms of better services, greater transparency, and lower costs?

These questions concern not just those who are active in financial markets. Just under one-third of the German general public own securities, and less than 20% are involved in the stock market.[18] But everyone is affected by developments in financial markets – including the 70% of people who don’t own securities.

Teaching people how the financial system works, explaining what happened during the Global Financial Crisis, illuminating frictions in financial markets, asking questions about the role that the financial system plays for society and welfare – all these aspects are key to the CORE concept. In this sense, I wish you every success with today’s conference, and hope the new German edition will stimulate interesting and insightful debate among students of economics.

One major problem in academic world is that it just values research and not teaching. So till research on crisis economics is relevant one can teach these things. Once the research needle moves from crisis economics to other areas, there are not enough people around interested to teach these ideas.