Re: Obituary: Franco Modigliani

["Barkley Rosser" <rosserjb@xxxxxxx>]

Paul,
      That is an unfortunately underappreciated
paper, and I am closely acquainted with some
of its authors.  It does need more publicizing.
      However, there are at least two caveats that
need to be noted before using it to simply dismiss
the life cycle hypothesis, which is not entirely
without empirical support.  The major problem
is that the JPKE paper was based on cross-section
rather than time-series data (unless I am mistaken,
which is possible).  Therefore, if the savings rate is
in general declining, which it has been for some
time in the US, it is not surprising that older people
tend to have higher savings rates.  They might
have had still higher ones when younger.  Also,
there may be a selection effect, those who save
more live longer.  This would also bias the results.
Barkley Rosser
----- Original Message -----
From: "pdavidso" <pdavidso@xxxxxxx>
To: "Matias Vernengo" <matias.vernengo@xxxxxxxxxxxxxxxxxx>
Cc: <pkt@xxxxxxxxxxxxxxxx>
Sent: Saturday, September 27, 2003 7:11 PM
Subject: Re: Obituary: Franco Modigliani


> >===== 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
>
>