Why Mundell Won the Nobel
For work that led to the euro, not for his supply-side theory

The core of the Reagan Revolution of the 1980s was the idea that cutting taxes would stimulate the economy by restoring people's incentives to work and invest. Big tax cuts, President Reagan argued, would actually increase government revenues in the long run. Reagan learned his supply-side economics from the likes of Jack Kemp, Jude Wanniski, and Arthur B. Laffer. They, in turn, took their inspiration from a Canadian-born economist at Columbia University named Robert A. Mundell.

Video:BW's Peter Coy
on Robert Mundell
Naturally, supply-siders were ecstatic on Oct. 13 when Mundell was named the winner of the 1999 Nobel prize in economics. Exulted Wanniski, head of Polyconomics Inc. in Morristown, N.J.: ''Mundell is the most important economist of our time.'' Laffer said Mundell's prize is ''absolutely the most deserved prize I've ever seen in my life'' and called Mundell ''the best economist in the world today.''

But it's wrong to conclude that Mundell's prize constitutes an endorsement of supply-side economics by the Royal Swedish Academy of Sciences. The phrase doesn't even appear in its award announcement. Instead, the academy cites Mundell for his theoretical work in the 1960s on monetary and fiscal policy in open economies.

What's more, although Mundell is a fervent believer in tax cuts, he isn't as doctrinaire about supply-side theory as his own followers are. For instance, he believes that tight monetary policy triggered the Depression--a demand-side explanation that's anathema to supply-siders. Says Wanniski: ''I often accuse him of being not as 'Mundellian' as I am.'' Massachusetts Institute of Technology economist Rudiger W. Dornbusch, who studied under Mundell, says it's typical of his former professor to ''plant bombs and move on.''

Whatever his role in setting off the Reagan Revolution, Mundell's contribution to economic theory has been significant. In the 1960s, he originated the concept of the ''optimal currency area,'' which framed the debate that led this year to the creation of a single currency, the euro, for Western Europe. As Mundell defined an optimal currency area, a region should use a single currency only if the economies in it are alike enough that a single currency, and hence a single monetary policy, will work for all. He wrote this year that the euro ''may be the most important development in the international monetary system since the dollar replaced the pound sterling as the dominant international currency soon after the outbreak of World War I.''

PREVIEW. Being Canadian influenced Mundell's work. Canada floated its currency in the 1960s while other nations were still pegged to the gold standard, so he got a preview of what would happen after the Bretton Woods agreement broke down in 1973. He demonstrated that with a floating currency and free capital flows, fiscal policy can't affect overall demand because changes in government spending trigger changes in interest rates, exchange rates, and trade flows that are exactly offsetting. Says Paul A. Samuelson, who taught Mundell at MIT: ''He brought [a focus on] money back into international trade.''

With fiscal conservatism taking precedence over tax cuts in Washington these days, it's easy to see why supply-siders are gleeful over Stockholm's seeming recognition of one of their own. But supply-side economics is not what earned Mundell his Nobel.

By Peter Coy in New York

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