Modigliani, Franco
Modigliani, Franco 1918-2003
Franco Modigliani was an Italian-born Jewish-American economist. He fled the fascist and anti-Semitic regime of Benito Mussolini (1883–1945) in 1939 and migrated to the United States with a doctor of law degree (1939) from the University of Rome. He earned a doctorate in economics from the New School University in New York in 1944, writing his dissertation on the Keynesian liquidity preference. In his dissertation, he reworked the Hicksian IS and LM curves to present a new version of Keynesian economics. His Keynesian paradigm laid the foundation for the Federal Reserve Bank econometric model. In 1962 Modigliani joined the economics department of the Massachusetts Institute of Technology, where he stayed for the rest of his career.
Liquidity preference explains unemployment without wage rigidity. It posits a relationship of money to prices. The price of money is anything that can be exchanged for it. Money in the future is also a price with a discount rate Rt = (1 + rt )-1. Being flexible, the rate of interest will rise in tight money situations. People will raise cash by liquidating money instruments or through borrowing. Investment and savings will fall and be subsequently followed by a fall of income and employment. The demand for money will then fall to equal its supply. Essentially, Modigliani argued for a “rate of interest” to “output” adjustment consequent to a tight monetary policy, in contrast to classical economists, who argued for a “rate of interest” to “price of all goods” adjustment. By keeping policymakers on guard to supply an adequate quantity of money or to fix an appropriate interest rate, Modigliani made unemployment an equilibrating mechanism.
Modigliani rid the investment concept in corporate finance of its traditional utility and production analyses. The Modigliani-Miller hypothesis first argued that a firm trying to increase its value by moving from only equity to a mixture of debt and equity positions will encourage arbitrage among individual investors that would undo its actions, making value invariant to the debt/equity ratio. Second, the rate of return on equity is linearly dependent on the debt/equity ratio. If a firm's stock is $1,000, debt is $400, interest on debt is 0.05, and the expected rate of return is 0.1, then its return on equity will be . Third, new invest-600 ment opportunities are also independent of the debt/equity ratio. This three-part hypothesis abstracted from the effects of taxes and bankruptcy. The discussion was extended to a dividend invariance value model.
In Modigliani's second best-known hypothesis, the life-cycle hypothesis of saving (LCH), consumers receive income, Y, up to the end of their working life, N. They accumulate savings during their working year, and consume, C, uniformly during their lifetime, L > N. Since lifetime consumption must equal lifetime income, assuming no bequest, we can express CL = NY, or C = (N ǀ L ) Y, in which case the terms in parentheses represent the marginal propensity to consume. Fitting the LCH to labor income and net assets, A, the equation C = .766 Y + .073 A reconciled some anomalies of the post-World War II (1939–1945) period.
For his contributions to investment and consumption theories, Modigliani received the Nobel Prize in economics in 1985. He also contributed to economic policy debates, evolving the NIRU (noninflationary rate of unemployment) concept through the Phillips curve, and Okun's unemployment versus the gross domestic product gap relationship, public deficits, and reinstated personal savings into the post-Keynesian debate on the equilibrium profit rate, creating the dual or anti-Pasinetti theorem.
SEE ALSO Life-Cycle Hypothesis; Modigliani-Miller Theorems
BIBLIOGRAPHY
Ando, Albert, and Franco Modigliani. 1963. The “Life Cycle” Hypothesis of Saving: Aggregate Implications and Tests. American Economic Review 53 (1): 55–84.
Modigliani, Franco. 1944. Liquidity Preference and the Theory of Interest and Money. Econometrica 12: 45–88.
Modigliani, Franco. 1949. Studies in Income and Wealth. Vol. 11: Fluctuations in the Saving-Income Ratio: A Problem in Economic Forecasting. New York: National Bureau of Economic Research.
Modigliani, Franco. 1963. The Monetary Mechanism and Its Interaction with Real Phenomena. Review of Economics and Statistics 45: 79–107.
Modigliani, Franco. 1986. Life Cycle, Individual Thrift, and the Wealth of Nations. American Economic Review 76 (3): 297–313.
Modigliani, Franco. 1988. MM-Past, Present, Future. Journal of Economic Perspectives 2 (4): 149–158. Modigliani, Franco. 2003. The Keynesian Gospel According to Modigliani. American Economist 47 (1): 2–24. Modigliani, Franco, and Richard Brumberg. 1954. Utility Analysis and the Consumption Function: An Interpretation of Cross-Section Data. In Post-Keynesian Economics, ed. Kenneth K. Kurihara, 388–436. New Brunswick, NJ: Rutgers University Press.
Ramrattan, Lall, and Michael Szenberg. 2004. Franco Modigliani, 1918–2003: In Memoriam. American Economist 43 (1): 3–8.
Ramrattan, Lall, and Michael Szenberg. 2007. Franco Modigliani, A Mind That Never Rests: An Intellectual Biography. Houndmills, U.K.: Palgrave Macmillan.
Lall Ramrattan
Michael Szenberg