October 14, 1999

Major Business News

Mundell Wins Nobel in Economics
For Role in Creation of the Euro

By MICHAEL M. PHILLIPS
Staff Reporter of THE WALL STREET JOURNAL

Robert A. Mundell, one of the intellectual fathers of both the new European common currency and Reagan-era supply-side economics, won the Nobel Memorial Prize in Economic Science.

Mr. Mundell conducted innovative research into common currencies when the idea of the euro, Europe's new currency, was still a fantasy. The 66-year-old Columbia University professor, a native of Canada, also examined the implications of cross-border capital flows and flexible foreign-exchange rates when capital flows were still restricted and currencies still fixed to each other.

"Mundell chose his problems with uncommon -- almost prophetic --accuracy in terms of predicting the future development of international monetary arrangements and capital markets," the selection committee said in announcing the prize.

Hero of Economic Right

An eccentric, white-haired figure who once bought an abandoned Italian castle as a hedge against inflation, Mr. Mundell later became a hero of the economic right with his dogged defense of the gold standard and early advocacy of the controversial tax-cutting, supply-side economics that became the hallmark of the Reagan administration.

While the Nobel committee sidestepped his political impact in awarding Mr. Mundell the $975,000 prize for his work in the 1960s, his conservative fans celebrated the award as an endorsement of supply-side thinking.

"I know it will take a little longer, but history eventually will note that it was Mundell who made it possible for Ronald Reagan to be elected president," by providing the intellectual backing for the Reagan tax cuts, wrote conservative economist Jude Wanniski on his Web site (http://www.polyconomics.com/¹).

Mr. Mundell's advocacy of supply-side economics sprang from his work in the 1960s examining what fiscal and monetary policies are appropriate if exchange rates are either fixed -- as they were prior to the collapse of the gold-based Bretton Woods system in the early 1970s -- or floating, as they are in the U.S. and many other countries today.

One major finding has since become conventional wisdom: When money can move freely across borders, policy makers must choose between exchange-rate stability and an independent monetary policy. They can't have both.

Mr. Mundell's work has long had an impact on policy makers. In 1962, he wrote a paper addressing the Kennedy administration's predicament of how to spur the economy while facing a balance-of-payments deficit. "The only correct way to do it was to have a tax cut and then protect the balance of payments by tight money," he recalled in a 1996 interview. The Kennedy administration eventually came around to the same way of thinking.

Origins of Reaganomics

Mr. Mundell traces the supply-side movement to a 1971 meeting of distinguished economists, including Paul Volcker and Paul Samuelson, at the Treasury Department. At the time, most economists were stumped by the onset of stagflation -- a combination of inflationary pressures, a troubled dollar, a worsening balance of payments and persistent unemployment. They thought any tightening of monetary or fiscal policy would bolster the dollar and improve the balance of payments, but worsen unemployment. An easing of monetary or fiscal policy might generate jobs, but weaken the dollar, lift prices and expand the balance-of-payments deficit.

Mr. Mundell suggested a heretical solution: Raise interest rates to protect the dollar, but cut taxes to spur the economy. Most others in the room were aghast at the idea, fearing tax cuts would lead to a swelling budget deficit -- something many nonsupply-siders believe was exactly what happened during the Reagan years.

"I knew I was in the minority," he said in an 1988 interview. "But I thought my vote should count much more than the others because I understood the subject."

At the University of Chicago early in his career, Mr. Mundell befriended a student named Arthur Laffer, and together they were at the core of the supply-side movement. Even today, Mr. Mundell predicts similar policies will be necessary to keep the U.S. economic expansion going. "Monetary policy isn't going to be enough to stay up there and avoid a recession," he said in an interview Wednesday. "We'll have to have tax reduction, too."

While in Chicago, he found himself constantly at odds with Milton Friedman, who advocated monetary rules and floating exchange rates. Mr. Mundell joined Columbia in 1974, two years before Mr. Friedman won the economics Nobel.

Ever the maverick, Mr. Mundell remains a fan of the gold standard and fixed exchange rates at a time when they're out of favor with most other economists. "You have fixed rates between New York and California, and it works perfectly," he said.

'A Wacko Thing to Work On'

The Nobel committee also praised Mr. Mundell's research into common currency zones, which laid the intellectual foundation for the 11-country euro. In 1961, when European countries still clung to their national currencies, he described the circumstances in which nations could share a common currency.

"At the time, it just seemed like such a wacko thing to work on, and that's why it's so visionary," said Kenneth Rogoff, a Harvard economist.

In particular, Mr. Mundell argued that in any successful currency zone, workers must be able to move freely from areas that are slowing to areas that are booming. Some critics suggest the euro nations don't fit his description.

But Mr. Mundell believes the new currency will eventually challenge the dollar for global dominance. "The benefits will derive from transparency of pricing, stability of expectations and lower transactions costs, as well as a common monetary policy run by the best minds that Europe can muster," Mr. Mundell wrote last year. He began working on the euro project as a consultant to European monetary authorities in 1969.

Outside academia, Mr. Mundell has led a colorful life. Worried about the onset of inflation in the late 1960s, he bought and renovated a 16th century Italian castle originally built for Pandolfo Petrucci, the "Strong Man of Siena." Mr. Mundell has four children, who range in age from one to 40.

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