Edward C. Prescott, whose work explaining the economic shocks of the 1970s catalyzed new ways of thinking about fiscal and monetary policy, a breakthrough that earned him a Nobel economics prize, died Nov. 6 at a care facility in Paradise Valley, Ariz. He was 81.
His son, Ned, said the cause was cancer.
Dr. Prescott was a leading member of the generation of economic thinkers who in the 1970s confronted the collapse of Keynesian models, which had dominated policymaking since the 1930s but proved to be unable to account for the decade’s high inflation and low growth.
Keynesian economics is largely focused on demand, changes in which, it posits, cause the business cycle to fluctuate. But Dr. Prescott, working with his frequent collaborator Finn Kydland, asked whether the supply side — like energy costs, and especially technological progress — could be just as important, if not more so.
In fact, their work, especially in a seminal 1982 paper, demonstrated that supply-side shifts explained the vast majority of changes in the business cycle since the end of World War II. Their research helped ignite decades of policies, beginning under President Reagan, that aimed to reduce taxes and regulation in order to maximize supply-side efficiency.
John Maynard Keynes himself might have approved: As he once said, “Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist.”
And to be fair, Keynes didn’t have the advanced computer modeling systems that made Dr. Prescott’s work possible and that gave him and Kydland perspective on the economy as a dynamic system.
That understanding of dynamism related to their second critical insight, regarding what economists call time inconsistency. As they explained in a 1977 paper, politicians tend to set long-term policies and goals but then undercut them for short-term expediency.
They pointed, as one example, to public flood insurance. A government might declare that an area is too risky to build on, and refuse to insure it. But once people do build there, politicians are likely to cave to constituent pressure — and, in fact, people will build because they expect politicians to cave.
This credibility problem was particularly problematic for Dr. Prescott and Kydland when it came to central banks. The banks’ directors might make low inflation their primary long-term goal. But if they are subject to political pressure, they are likely to shift priorities to higher employment, even if it means higher inflation.
And because the economy is made up of individual actors — people, companies, governments — the results are dynamic, making it difficult to use the same policy tools in different situations.
“Macro policy is a game, not a control problem as we had thought,” Dr. Prescott wrote in an autobiographical sketch after winning the 2004 Nobel Memorial Prize in Economics.
Therefore, he argued, governments should set long-term rules and keep to them — by, for example, insulating central banks from political pressure and setting multiyear budgets.
Both of those insights came in the late 1970s. Dr. Prescott returned to public prominence in 2004, the same year he won the Nobel, with a paper exploring 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.
Such findings led Dr. Prescott to sign a letter with 367 other economists criticizing a proposal by Senator John Kerry of Massachusetts, the 2004 Democratic presidential nominee, to roll back tax cuts on high-income earners.
“The idea that you can increase taxes and stimulate the economy is pretty damn stupid,” Dr. Prescott told reporters.
For their work, Dr. Prescott and Kydland shared the 2004 Nobel.
“They offered a new and operational paradigm for macroeconomic analysis based on microeconomic foundations,” the Nobel committee wrote. “Kydland and Prescott’s work has transformed academic research in economics, as well as the practice of macroeconomic analysis and policymaking.”
Edward Christian Prescott was born on Dec. 26, 1940, in Glens Falls, N.Y., a city on the Hudson River north of Albany. His interest in economics sprouted early, after he observed his father, William, an industrial engineer, manage factory operations. His mother, Mathilde (Helwig) Prescott, was a librarian and homemaker.
Edward played football in high school and college, even though he was physically slight, and worked summers as a golf caddie and in a nearby paper mill.
He entered Swarthmore College planning to study physics on the way to a career in rocket science, but he came to see the school’s department as insufficiently theoretical. He switched to mathematics and graduated in 1963.
He received a master’s degree in operations research from the Case Institute of Technology, in Cleveland, and a doctorate in economics from the Carnegie Institute of Technology in 1967, the same year the school merged with the Mellon Institute to form Carnegie Mellon University.
He married Janet Dale Simpson in 1965. Along with his wife and son Ned, Dr. Prescott leaves a daughter, Wynn; another son, Andrew; a brother, William; a 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 a consultant for the Federal Reserve Bank of Minneapolis.
At one point he almost took a job at the University of Chicago but decided against it because his son Ned was a graduate student in the university’s economics department, and he didn’t want to run the risk of a conflict of interest. Ned Prescott now works for the Cleveland Fed.