- Person
- Franco Modigliani
- Lived
- 1918–2003
- Field
- Economics & finance
- From
- Italian-American
The story
Franco Modigliani's interest in expectations began at the University of Illinois. After arriving in America as a refugee in 1939 and earning his doctorate at the New School, he spent a year at the Cowles Commission in Chicago, then the leading centre for mathematical economics. He then accepted a post at the University of Illinois directing a research project on Expectations and Business Fluctuations, studying how the way people anticipate the future drives the ups and downs of business activity.
In 1952 he moved to the Carnegie Institute of Technology, and the eight years that followed were among the most productive of his life. There he completed the papers on the life-cycle hypothesis of saving, wrote two famous essays with Merton Miller on how a firm's financing and dividend policy affect its value, and collaborated on a book about how firms can best smooth production over time.
He also wrote, with Emile Grunberg, a paper on a subtle problem: can social and economic events be predicted when the people involved react to the prediction itself? A forecast that prices will rise, or that a recession is coming, can change how consumers and businesses behave, and so change the outcome. Grunberg and Modigliani took the problem seriously and analysed how a forecaster could allow for those reactions. The paper was published in 1954.
Modigliani later wrote that the paper provided one of the pillars of the theory of rational expectations, and many economists consider the idea to originate there. In 1961 John Muth formally introduced the concept of rational expectations, and in the following decades it reshaped macroeconomics, influencing how economists model inflation, financial markets and the effects of government policy.
He saw his Carnegie work as the fruit of seeds planted during the Illinois project on expectations. Questions about how people look ahead ran through his whole career, from saving for old age to the pricing of shares to the effects of inflation and the design of stabilisation policy.
Why it matters
The paper helped economists take seriously how people's expectations shape economic outcomes, an idea now central to economics and central banking.
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 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 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: Biographical NobelPrize.org
- Rational expectations Wikipedia
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