- Person
- Franco Modigliani
- Lived
- 1918–2003
- Field
- Economics & finance
- From
- Italian-American
The story
Central banks constantly face a difficult trade-off: how far can unemployment fall before prices start to rise too quickly? Milton Friedman had proposed the idea of a natural rate of unemployment, a level set by the structure of the labour market that policy could push below only by accepting ever-faster inflation. The idea was influential but controversial.
Franco Modigliani spent much of his later career at MIT on inflation, its effects and its cures. In 1975, in a paper written with his former student Lucas Papademos, he introduced the concept of the NIRU, the non-inflationary rate of unemployment. They defined it as the rate of unemployment above which inflation could be expected to decline, and they tried to estimate it from real data. It was presented as an improvement on the natural rate. The economist James Tobin suggested that they chose a new term to avoid the normative implications of calling any level of unemployment natural.
The idea spread under the closely related name NAIRU, the non-accelerating inflation rate of unemployment, which largely replaced the natural rate in economic discussion. Unlike the natural rate, the NAIRU did not commit economists to any one theory or policy remedy, or to the assumption that the rate stays fixed over time.
Modigliani did not treat high unemployment as something to be accepted. He took part actively in policy debates in both Italy and the United States, and in the late twentieth century he argued, along with heterodox economists who otherwise criticised him, that the high unemployment across Europe was caused by a lack of demand induced by austerity policies. Even those critics acknowledged his dissenting voice on the issue.
The NIRU and the NAIRU remain central concepts in the way central banks think about balancing jobs and stable prices, and debates over how low unemployment can safely go still begin from the questions Modigliani and Papademos tried to answer with data.
Why it matters
The NIRU gave policymakers a practical way to think about balancing jobs and stable prices, and Modigliani used his authority to argue for reducing unemployment.
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 explained how people save over a lifetimeWith his student Richard Brumberg, Franco Modigliani developed the life-cycle hypothesis of saving in 1953–54, a key reason for his 1985 Nobel Prize.
- 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 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
- Franco Modigliani Wikipedia
- Franco Modigliani: Biographical NobelPrize.org
- Non-accelerating inflation rate of unemployment Wikipedia
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