Franco Modigliani

Franco Modigliani

Nobel Prize-winning economist

Franco Modigliani, an American born in Italy, won the 1985 Nobel Prize for two contributions. The first was "his analysis of the behavior of household savers." In the early fifties Modigliani, trying to improve on Keynes's consumption function, introduced his "life cycle" model of consumption. The basic idea was common sense, but no less powerful for that reason. Most people, he claimed, want to have a fairly stable level of consumption. If their income is low this year, for example, but expected to be high next year, they do not want to live like paupers this year and princes next. So in high-income years, Modigliani argued, people save. They spend more than their income (dissave) in low-income years. Because income begins low for young adults just starting out, then increases in the middle years, and declines on retirement, said Modigliani, young people borrow to spend more than their income, middle-aged people save a lot, and old people run down their savings.

The second contribution that helped Modigliani win the Nobel Prize was the famous Modigliani-Miller theorem in corporate finance (see Corporate Debt). Modigliani, together with Merton Miller, showed that under certain assumptions, the value of a firm is independent of its ratio of debt-to-equity. Although Modigliani claims his two articles with Miller were written tongue-in-cheek, that is not how Miller, the Nobel Prize Committee, or financial economists took their two articles. Their insight was a cornerstone in the field of corporate finance.

Modigliani also wrote one of the articles that started the rational expectations school of economics (see Rational Expectations). In a 1954 article he and coauthor Emile Grumburg pointed out that people may anticipate certain government policies and act accordingly. Modigliani strenuously objects, though, to how far the rational expectations school has run with this basic insight.

Modigliani considers himself a Keynesian. A cartoon on his office door in 1982 said: "With your permission, gentlemen, I'd like to offer a kind word on behalf of John Maynard Keynes." Modigliani left fascist Italy in 1939, because he was both Jewish and antifascist. He earned his Ph.D. from the New School of Social Research in 1944. Modigliani taught at the New School from 1944 to 1949 and was a research consultant to the Cowles Commission at the University of Chicago from 1949 to 1952. He was a professor at Carnegie Institute of Technology from 1952 to 1960, at Northwestern University from 1960 to 1962, and at MIT from 1962 to the present. He was president of the American Economic Association in 1976.

Franco Modigliani
Landon Lecture
April 21, 1987