- Person
- Franco Modigliani
- Lived
- 1918–2003
- Field
- Economics & finance
- From
- Italian-American
The story
Why do people save, and how much? In 1936 John Maynard Keynes proposed that households spend more as their income rises, but not by as much, so that a growing economy should save an ever larger share of its income. In 1942 Simon Kuznets showed that the facts did not fit: in the United States the long-term ratio of saving to income had not risen over time. Economists spent years trying to explain the puzzle.
Franco Modigliani took up the question after studying saving in the 1940s. At the University of Illinois, where he directed a research project on expectations and business fluctuations, he befriended a brilliant young graduate student, Richard Brumberg. Together they laid the foundations of what became the life-cycle hypothesis, set out in two papers in 1953 and 1954, one on individual behaviour and the other on the saving of a whole economy. Their central idea is that people plan their spending over their whole lives. They aim to keep consumption fairly steady, building up wealth during their working years and drawing it down in old age.
Modigliani then drew out the consequences for the whole economy. The theory implies that a nation's saving depends mainly on its rate of growth, and on demographic factors such as the age structure of the population and life expectancy. Brumberg's early death in 1955 so shook Modigliani that the aggregate paper was published only in 1980, in his collected papers.
In 1985 the Royal Swedish Academy of Sciences awarded Modigliani the Nobel Memorial Prize in Economic Sciences, citing the life-cycle hypothesis as one of his two key achievements. The Academy called it a new paradigm in the study of consumption and saving and the basis of most dynamic models used in the field. It noted that the theory had proved an ideal tool for analysing the effects of different pension systems.
Modigliani himself kept applying it to real problems. A book he wrote with Arun Muralidhar, Rethinking Pension Reform, was published in 2004, the year after his death. Today the life-cycle idea underlies the way economists, governments and financial planners think about retirement saving and about how ageing populations affect national economies.
Why it matters
The life-cycle hypothesis became a basic tool for thinking about pensions, retirement saving and how ageing populations affect the economy.
About Franco Modigliani
Rome-born economist who fled Mussolini’s racial laws and, at MIT, explained how people save over a lifetime and how firms are valued, winning the 1985 Nobel Prize.
More about Franco Modigliani
- Franco Modigliani bridged Keynes and classical economicsFranco Modigliani’s 1944 doctoral paper, “Liquidity Preference and the Theory of Interest and Money”, integrated Keynes’s revolution with classical economics.
- Franco Modigliani built a model used by the Federal ReserveIn the late 1960s Franco Modigliani led the design of a large model of the US economy for the Federal Reserve, a tool that guided monetary policy for decades.
- Franco Modigliani introduced the NIRU unemployment conceptIn 1975 Franco Modigliani and his former student Lucas Papademos introduced the NIRU, the non-inflationary rate of unemployment, a concept still debated in monetary policy.
- Franco Modigliani helped found rational expectationsAt Carnegie Tech, Franco Modigliani and Emile Grunberg published a paper on predicting social events when people react to predictions, a pillar of rational expectations theory.
- Franco Modigliani inspired generations of MIT studentsFranco Modigliani taught at MIT for about 40 years. Paul Samuelson called him a great teacher whose students included Nobel laureate Robert Merton.
- Franco Modigliani’s theorem reshaped corporate financeIn 1958 Franco Modigliani and Merton Miller showed that, under certain assumptions, a firm’s value does not depend on whether it is financed by debt or by shares.
Sources
- The Prize in Economic Sciences 1985: press release NobelPrize.org
- Franco Modigliani: Biographical NobelPrize.org
Another act of tikkun olam. This is part of tikkun olam, the Jewish idea of repairing the world, and every one of us can add to it.