Rand Fishkin over at SEOmoz
tied Matt Cutts to a chair and pleaded with him asked Matt to provide some clarifications regarding the nofollow attribute. Matt essentially said that nofollow links aren't followed, but you can exercise control over what is followed ("fine-grained control," as he puts it) by implementing nofollow. He had the following to say:
The nofollow attribute is just a mechanism that gives webmasters the ability to modify PageRank flow at link-level granularity. Plenty of other mechanisms would also work (e.g. a link through a page that is robot.txt'ed out), but nofollow on individual links is simpler for some folks to use. There's no stigma to using nofollow, even on your own internal links; for Google, nofollow'ed links are dropped out of our link graph; we don't even use such links for discovery. By the way, the nofollow meta tag does that same thing, but at a page level.
Matt then adds to the comments:
I think saying people "should be" using nofollow is a bit strong. More like people can use it for internal links if they're power-user-y enough to want to sculpt PageRank flow within their site at the link level. But I'd say that most regular webmasters don't need to worry about link-level PageRank flow within their site. I think saying "power users and webmasters should be employing on their sites" overstates it a little. It's available if you want to get into that much fine-grained control.
This insight into the behavior of nofollow has welcomed the WebmasterWorld community. A clearer picture has been desired and it is now provided.
In the end, though, use caution when employing this feature.
Anybody who uses nofollow "to modify PageRank flow at link-level granularity" (luv that engineer talk), must be absolutely sure it doesn't inadvertently orphan any important pages.
Forum discussion at WebmasterWorld.