The Nobel Prize

Franco Modigliani (1918–2003)

Franco Modigliani was born in Rome, Italy in 1918. At the age of 17 he entered the University of Rome to study law and obtained his degree in law in 1939. At the start of the Second World War he emigrated to the United States (later becoming a US citizen) where he obtained a scholarship to study economics at the New School for Social Research, New York City in the autumn of 1939. Between 1942 and 1944 he was an Instructor in Economics and Statistics at Bard College, Columbia University. In 1943 he returned to the New School for Social Research (where he received his doctoral degree in 1944), first as a lecturer (1943–44) and then as Assistant Professor of Mathematical Economics and Econometrics (1946–48), before leaving New York to join the Cowles Commission as a research consultant (1949–54). In 1949 he joined the University of Illinois as an associate professor and subsequently became Professor of Economics (1950–52). Between 1952 and 1960, Modigliani was Professor of Economics and Industrial Administration at Carnegie Institute of Technology (now Carnegie-Mellon University) and, after a brief spell at Northwestern University (1960–62) as Professor of Economics, he moved to Massachusetts Institute of Technology (MIT) as Professor of Economics and Finance in 1962 where he taught until his retirement in 1988. Between 1964 and 1972, Modigliani was a consultant to the Secretary to the US Treasury and from the mid1960s a consultant to the Board of Governors of the Federal Reserve System. From 1971 he was a senior adviser to the Brookings Panel on Economic Activity.

Modigliani’s many offices and honours included: presidencies of the Econometric Society (1962), the American Economic Association (1976), the American Finance Association (1981), and honorary presidency of the International Economic Association (1983). In 1985 he was awarded the Nobel Memorial Prize in Economics ‘for his pioneering analyses of saving and of financial markets’ (Nobel Foundation, 2004).


Modigliani is best known for his seminal contributions to three main areas: macroeconomic and monetary theory; the theory of saving; and the theory of finance. His published research output in macroeconomics and monetary theory began with his highly influential 1944 Econometrica article, ‘Liquidity Preference and the Theory of Interest and Money’, which was largely based on his doctoral dissertation. In the article, Modigliani argued that wage rigidity is the crucial hypothesis for explaining underemployment equilibrium in the Keynesian system and that, apart from the special case of the liquidity trap, the main weapon for stabilisation policy is monetary policy, not fiscal policy. In a subsequent article, Modigliani (1963a) refined his analysis, returning to address the issue in ‘The Monetarist Controversy or, Should We Forsake Stabilization Policies?’, his 1976 Presidential Address to the American Economic Association (Modigliani, 1977). In addition to his theoretical contributions in this area he also sought to test the effects of policy changes on the economy. Working in collaboration with Albert Ando (University of Pennsylvania) in the mid-1960s, he designed and constructed an econometric model of the US economy for the Federal Reserve known as the FMP model (Federal Reserve–MIT–University of Pennsylvania model) to be used for forecasting and stabilisation purposes. In helping to extend Keynesian economics, Modigliani consistently argued that a market economy ‘needs to be stabilized, can be stabilized, and therefore should be stabilized by appropriate monetary and fiscal policies’ (Modigliani, 1977, p. 1; see also Modigliani, 1986).


His research into the theory of saving began in the early 1950s, while at the University of Illinois, in collaboration with Richard Brumberg, then a graduate student at the university. Their work, which has come to be referred to as the ‘life-cycle hypothesis’ of saving and consumption, was developed in two seminal papers which were published after both had left the University of Illinois (Modigliani and Brumberg, 1954; 1980a). Although the second paper was completed before Brumberg died prematurely in 1955, Modigliani, upset by the death of his friend, did not look at the paper for a long time afterwards and it was not published until 1980. According to the life-cycle hypothesis, an individual’s current consumption depends on, and is some fraction of (depending on tastes and preferences), the present value of his or her lifetime resources, which are composed of the person’s wealth and lifetime earnings (both current income and expected future income from employment). The theory assumes that an individual will maximise his or her utility by maintaining a stable or smooth pattern of consumption over their entire lifetime. A joint article with Albert Ando (1963b), published in the American Economic Review, sought to test the hypothesis and examine its implications. One of the main macroeconomic implications of the hypothesis is that aggregate saving depends primarily on the rate of growth of income, not on income per capita.


The third area of research for which Modigliani is best known is his work in the field of the theory of finance. In two articles written with Merton Miller (who subsequently was awarded the Nobel Memorial Prize in Economics, jointly with Harry Markowitz and William Sharpe, in 1990) they produced what have come to be known as the ‘Modigliani–Miller theorems’. In the first of these papers Modigliani and Miller (1958) showed that in a competitive market with rational investors, ignoring the effects of taxes, the financial structure (debt–equity ratio) of a firm has no effect on its market value. In the second paper, Modigliani and Miller (1961) argued that dividend policy has no effect on the market value of a firm’s shares. In other words, the market value of a firm’s shares will be independent of its policy choice between paying dividends to shareholders or retaining earnings. The Modigliani–Miller theorems have a number of important implications, most notably for investment decisions. This pioneering work paved the way for subsequent research in the field and the development of the modern theory of finance.

In addition to his path-breaking contributions to these three areas, Modigliani also made an influential contribution to the field of management science through his co-authored book, with Charles Holt, John Muth and Herbert Simon (the 1978 Nobel Memorial Laureate), Planning, Production and Work Forces, published in 1960. Many of Modigliani’s most important papers have been gathered together in five volumes (see Modigliani, 1980b; 1989).


Main Published Works
(1944), ‘Liquidity Preference and the Theory of Interest and Money’, Econometrica, 12, January, pp. 45–88.
(1954), ‘Utility Analysis and the Consumption Function: An Interpretation of Cross-Section Data’ (with R. Brumberg) in K.K. Kurihara (ed.)

(1954), Post-Keynesian Economics, New Brunswick, NJ: Rutgers University Press, pp. 388–436; reprinted in A. Abel (ed.)

(1980), The Collected Papers of Franco Modigliani, vol. 2, The Life Cycle Hypothesis of Saving, Cambridge, MA: MIT Press.
(1958), ‘The Cost of Capital, Corporation Finance and the Theory of Investment’ (with M.H. Miller), American Economic Review, 48, June, pp. 261–97; reprinted in A. Abel (ed.)

(1980), The Collected Papers of Franco Modigliani, vol. 3, The Theory of Finance and Other Essays, Cambridge, MA: MIT Press.
(1960), Planning Production, Inventories and Work Forces (with C.C. Holt, J. Muth and H.A. Simon), Englewood Cliffs, NJ: Prentice-Hall.
(1961), ‘Dividend Policy, Growth and the Valuation of Shares’ (with M.H. Miller), Journal of Business, 34, October, pp. 411–33; reprinted in A. Abel (ed.)

(1980), The Collected Papers of Franco Modigliani, vol. 3, The Theory of Finance and Other Essays, Cambridge, MA: MIT Press.
(1963a), ‘The Monetary Mechanism and its Interaction with Real Phenomena’, Review of Economics and Statistics, 45, February, pp. 79–107; reprinted in A. Abel (ed.)

(1980), The Collected Papers of Franco Modigliani, vol. 1, Essays in Macroeconomics, Cambridge, MA: MIT Press.
(1963b), ‘The “Life Cycle” Hypothesis of Saving: Aggregate Implications and Tests’ (with A. Ando), American Economic Review, 53, March, pp. 55–84; reprinted in A. Abel (ed.)

(1980), The Collected Papers of Franco Modigliani, vol. 2, The Life Cycle Hypothesis of Saving, Cambridge, MA: MIT Press.
(1977), ‘The Monetarist Controversy or, Should We Forsake Stabilization Policies?’, American Economic Review, 67, March, pp. 1–19; reprinted in A. Abel (ed.)

(1980), The Collected Papers of Franco Modigliani, vol. 1, Essays in Macroeconomics, Cambridge, MA: MIT Press.
(1980a), ‘Utility Analysis and Aggregate Consumption Functions: An Attempt at Integration’ (with R. Brumberg) in A. Abel (ed.)

(1980), The Collected Papers of Franco Modigliani, vol. 2, The Life Cycle Hypothesis of Saving, Cambridge, MA: MIT Press.
(1980b), The Collected Papers of Franco Modigliani: vol. 1, Essays in Macroeconomics; vol. 2, The Life Cycle Hypothesis of Saving; vol. 3, The Theory of Finance and Other Essays (ed. A. Abel), Cambridge, MA: MIT Press.
(1986), The Debate Over Stabilization Policy, Cambridge: Cambridge University Press.
(1989), The Collected Papers of Franco Modigliani: vol. 4, Monetary and Stabilisation Policies; vol. 5, Savings, Deficits, Inflation and Financial Theory (ed. S. Johnson), Cambridge, MA: MIT Press.
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