Re: Obituary: Franco Modigliani

[pdavidso <pdavidso@xxxxxxx>]

>===== Original Message From Matias Vernengo
<matias.vernengo@xxxxxxxxxxxxxxxxxx> =====
>Obituary: Franco Modigliani by Martin Wolf Published: September 26 2003
>17:41 | Last Updated: September 26 2003 17:41 .l { visibility: hidden;
>display: block; }
>
>
>Franco Modigliani, who has died at the age of 85, was
>the winner of the Nobel Prize for Economics in 1985 Modigliani made seminal
>contributions to macroeconomics - particularly the "life-cycle" savings
>hypothesis, which he developed in collaboration with Richard Brumberg -


>The life-cycle theory of savings arose out of an interest in Keynesian
>economics, which suggested that people would save an ever higher proportion
>of their incomes the richer they became. The consequent excess of savings
>could, it was feared, lead to depression.

>Modigliani's first response, published in 1949, was the idea that savings are
>determined more by a person's income relative to his accustomed level than
>by his absolute income in a given period. In 1954, Modigliani published the
>first paper on the life-cycle hypothesis - co-authored by his pupil, Richard
>Brumberg. In this model, current consumption is determined by expected life-
>time incomes. As people would, argued the authors, wish to consume the
>same amount (in real discounted terms) each year, savings would be
>determined by the difference between current incomes and planned
>consumption. Consequently, an individual's life-time savings would show a
>hump: low in early adulthood, high during the middle years and negative in
>retirement.


Unfortunately, the empirical facts do not support the life cycle hypothesis.
Researchers from the Po\verty In stitute of the University of Wisconsin
reported , in a study published in the JOURNASL OF POST KEYNESIAN ECONOMICS,
that they took a surveys over time of over 6000 households whose head of
household was 65 years or older -- and found that after adjusting for income
(using several different definitions of income), the average propensity to
save  INCREASED with age .  In essence 70 year olds, cetteris paribus, saved
more than 65 year olds for any given income level, 75 year olds saved more
than 70 year olds, etc.

These facts have never been disputed -- and Modigliani knew about this
published study -- and never even tried to refute! He just ignored it --as did
many of his Establishment colleagues at MIT, Chicago, etc.  and he received
the Nobel prize for the life cycle fiction -- even though it was known to be
empirically invalid!!


And I should point out -- that Franco and I were friends -- not enemies --
during our concurrent service on the Brookings Panel and after.




>The life-cycle hypothesis also has implications for the behaviour of savings
in
>the economy as a whole. Even if individuals consume their entire lifetime
>incomes, an economy will have positive savings, provided incomes are rising.


But the implications are even greater if the life cycle hypothesis is rejected
by empirical data


>Each generation is then richer than its predecessor and so saves more in
>middle-age than its predecessor dissaves in its old age.



And if olders do not dissave then what?


>Modigliani's work on corporate finance was as path-breaking. In the late
>1950s he and Merton Miller produced two papers on the financial structure of
>the firm and on dividend policy. The first, published in 1958, argued that
the
>debt-equity ratio of a firm should have no effect on its market valuation in
a
>perfect capital market. The second, published in 1961, maintained that the
>dividend policy of the firm should also have no bearing on its valuation. The
>approach taken in these papers is that investors can create leverage by
>borrowing against shares, they can undo leverage by buying a company's
>bonds and they can create dividends by selling a company's shares.

Later on the Modgiliani -Miller corporate finace model was also shown to be at
oddss with the facts. But who cares?-- as Miller got a Nobel prize or that --
thereby implicitly giving Franco a second Nobel prize.


Paul

Paul Davidson
Editor, Journal of Post Keynesian Economics
University of Tennessee
SMC 503
Knoxville, Tennessee 37996-0550
office phone #;(865)974-4221; office fax# (865)974-1686 or (865)974-4601
home phone and fax # (865)692-0802
email pdavidson@xxxxxxx
http://econ.bus.utk.edu/davidsonextra/Davidson.html