The Nobel Prize

James Tobin (1918–2002)

James Tobin was born in Champaign, Illinois, USA in 1918. In receipt of a scholarship, he studied at Harvard University earning a BA in 1939 and an MA in 1940. His graduate studies at Harvard were interrupted by his wartime service, first as a junior economist in the US Office of Price Administration and Civilian Supply and War Production from 1941 to 1942, and then from 1942 to 1946 when he served in the US Navy. In 1946 Tobin returned to Harvard to complete his doctoral thesis on the theory and statistics of the consumption function, and was awarded a PhD in 1947. Tobin then taught at Harvard for three years as a junior fellow during which time he spent a year in England as a visitor to the Department of Applied Economics at Cambridge University from 1949 to 1950. In 1950 he joined the economics department at Yale University as an associate professor, later holding the posts of Professor of Economics (1955–57), Sterling Professor of Economics (1957–88), and chairman of the Economics Department (1968–69 and 1974–78). At Yale he also served as director of the Cowles Foundation for Research in Economics from 1955 to 1961 and from 1964 to 1965. From 1988, until his death in 2002, he was Sterling Professor, Emeritus, at Yale University.

As is evident from this brief biographical overview, Tobin spent almost his entire career at Yale, with the notable exceptions of a year as each of: a member of President Kennedy’s Council of Economic Advisers in Washington, DC in 1961–62; a Rockefeller Foundation Visiting Professor at the University of Nairobi’s Institute for Development Studies in 1972–73; visiting professor at the University of Minnesota in 1978; and Ford Visiting Research Professor at the University of California, Berkeley in 1983.

Tobin’s many offices and honours included the award of the John Bates Clark Medal of the American Economic Association in 1955, and presidencies of the Econometric Society (1958), the American Economic Association (1971) and the Eastern Economic Association (1977). In 1981, Tobin was awarded the Nobel Memorial Prize in Economics ‘for his analysis of financial markets and their relations to expenditure decisions, employment, production and prices’ (Nobel Foundation, 2004).

James Tobin is widely known as having been one, if not the most eminent, of the world’s Keynesian economists and has been described by Buiter (2003) as ‘the greatest macroeconomist of his generation’. A self-confessed ‘old-style’ Keynesian (Tobin, 1993), over the course of his long and distinguished career, Tobin modified, refined and extended many basic Keynesian ideas on how the economy works. While his most important contributions to economics are to be found in the interrelated fields of monetary and macroeconomic theory, he also contributed to the continuing debate over the role and conduct of stabilisation policy. Although he was a lifelong vigorous defender of orthodox Keynesian ideas, especially against the counter-revolutionary attacks posed by monetarism and new classical economics in the 1960s, 1970s and 1980s, he was none the less aware of shortcomings and inadequacies in some of the work of Keynes. Indeed, in his first published paper (Tobin, 1941), he criticised Keynes’s treatment of the relation of the money wage and aggregate employment. In much of his subsequent work he sought to clarify and develop Keynes’s analysis of a number of key relationships.

In his early work, Tobin concentrated on the monetary side of macroeconomics, in particular focusing his research on Keynesian liquidity preference. His 1947 paper, ‘Liquidity Preference and Monetary Policy’, was one of the first empirical studies to test for the interest elasticity of the demand for money in the United States. In two subsequent articles, Tobin refined and developed Keynes’s liquidity preference theory, thereby providing a much more rigorous and sophisticated analysis of the demand for money. In his 1956 paper, ‘The Interest Elasticity of Transactions Demand for Cash’, he used an inventory-theoretic approach to explain why the demand for transactions balances would be interest elastic. More significantly, in his seminal 1958 paper, ‘Liquidity Preference as Behaviour Towards Risk’ (Tobin, 1958b), he put forward a choice-theoretic model to explain why individual agents hold diversified portfolios, rather than holding only cash or only bonds as is implied in Keynes’s analysis. In his model, risk-averse individuals will diversify their portfolios between money (a safe asset with a zero yield) and risky assets (with an expected positive return). Agents will trade off the mean return against the variance of return expected on a portfolio of risky assets. Tobin’s 1958 paper famously introduced the ‘separation’ or ‘mutual fund’ theorem. According to the theorem, while differences in risk aversion affect the proportion in which individual investors divide their wealth between a ‘mutual fund’ of risky assets and the one safe asset, money, the composition of the fund is independent of individuals’ degree of risk aversion. His analysis of portfolio selection by individual households and firms between money and a range of assets, and his separation theorem, laid the foundations for the subsequent development of the theory of finance (see entries on Markowitz and Sharpe in this volume).

In another seminal paper published in 1969 entitled ‘A General Equilibrium Approach to Monetary Theory’, Tobin presented a summary of his theoretical framework in which he spelt out a complete model of asset equilibrium. In the paper he investigated the channels through which financial disturbances are transmitted to the real sector of the economy. Within the model, q, the ratio of the market value of a firm’s capital to the replacement cost of its capital – often referred to as Tobin’s q – is a key variable determining the flow of investment. Ceteris paribus, the higher the value of q, the higher investment will be. In the concluding remarks to his paper, Tobin suggested that ‘the principal way in which financial policies and events affect aggregate demand is by changing the valuation of physical assets relative to their replacement costs’ (Tobin, 1969, p. 29). While monetary policy can bring about such changes, so too can changes in asset preferences. Central to this and earlier analysis is the role of portfolio diversification and preferences towards risk within a general equilibrium setting.

Tobin also made important contributions to the theory of macroeconomic growth by analysing the links between short-run cyclical fluctuations and long-run economic growth. In a paper published in 1955 in the Journal of Political Economy, he constructed a dynamic model which allowed for the interaction of monetary and real factors in explaining both growth and cycles. In another important paper published in 1965 in Econometrica, ‘Money and Economic Growth’, he concluded that monetary policy can affect the degree of capital intensity in an economy. In his analysis, an increase in the rate of money growth leads to an increase in the rate of inflation which in turn causes portfolio substitution by individuals away from money towards capital.

Throughout his career Tobin remained faithful to his vision that Keynesian theory provides a foundation for activist stabilisation policy involving both monetary and fiscal policy. In the early 1970s, he participated in an, at times heated, exchange with Milton Friedman (see entry in this volume). In his 1970 Quarterly Journal of Economics paper he accused Friedman of falling foul of the post hoc ergo propter hoc fallacy of accepting the empirically observed tendency for monetary changes to precede changes in business activity as strong empirical support of propositions about causation. In his 1972 Journal of Political Economy paper (Tobin, 1972b) he criticised Friedman’s theoretical framework, while in his American Economic Review paper of the same year (Tobin, 1972a) he used the occasion of his presidential address to the American Economic Association to attack Friedman’s natural rate hypothesis and defend the existence of a trade-off between inflation and unemployment which could be exploited for stabilisation purposes. For more than four decades Tobin steadfastly and consistently defended the use of activist demand management against the attacks of monetarism and new classical economics and questioned, in the latter case, whether new classical models are plausible enough to guide policy (Tobin, 1980).

In addition to his contributions to the fields of monetary and macroeconomic theory, and the theory and practice of stabilisation policy outlined above, Tobin also made a number of wide-ranging contributions to economic analysis including: contributions to the theory and empirics of the life-cycle model of consumption and saving (see entry on Modigliani in this volume, and Tobin, 1975); the development of new statistical techniques such as the Tobit method for estimating relationships with limited dependent variables (Tobin, 1958a); the development of what has come to be known as the ‘Tobin tax’, a proposed uniform tax on foreign exchange transactions aimed at deterring short-term currency speculation (see, for example, Tobin, 1978 – his presidential address to the Eastern Economic Association); and papers on poverty and social policy and international economic relations.

A significant proportion of Tobin’s published work has taken the form of articles in learned journals. Many of his most important technical papers on macroeconomics, consumption and econometrics, theory and policy, and national and international issues, have been brought together in four volumes: Essays in Economics (Tobin, 1971; 1975; 1982; 1996b). A number of his less technical papers can be found in two collections containing policy-orientated essays he wrote from 1973 to 1986 (Tobin, 1987) and 1987 to 1994 (Tobin, 1996a). In addition to their style and clarity, which make them highly accessible to a wide audience, these collections also provide a clear statement of Tobin’s defence of Keynesian ideas and his pragmatic liberal activist philosophy.

Main Published Works
(1941), ‘A Note on the Money Wage Problem’, Quarterly Journal of Economics, 50, May, pp. 508–16.
(1947), ‘Liquidity Preference and Monetary Policy’, Review of Economics and Statistics, 29,
May, pp. 124–31.
(1955), ‘A Dynamic Aggregative Model’, Journal of Political Economy, 63, April, pp. 103–15.
(1956), ‘The Interest Elasticity of Transactions Demand for Cash’, Review of Economics and
Statistics, 38, August, pp. 241–7.
(1958a), ‘Estimation of Relationships for Limited Dependent Variables’, Econometrica, 26, January, pp. 24–36.
(1958b), ‘Liquidity Preference as Behaviour Towards Risk’, Review of Economic Studies, 25,
February, pp. 65–86.
(1965), ‘Money and Economic Growth’, Econometrica, 33, October, pp. 671–84.
(1969), ‘A General Equilibrium Approach to Monetary Theory’, Journal of Money, Credit and
Banking, 1, February, pp. 15–29.
(1970), ‘Money and Income: Post Hoc Ergo Propter Hoc?’, Quarterly Journal of Economics, 84,
May, pp. 301–17.
(1971), Essays in Economics, Vol. 1: Macroeconomics, Chicago: Markham Publishing Co.
(1972a), ‘Inflation and Unemployment’, American Economic Review, 62, March, pp. 1–18.
(1972b), ‘Friedman’s Theoretical Framework’, Journal of Political Economy, 80, September–
October, pp. 319–37.
(1975), Essays in Economics, Vol. 2: Consumption and Econometrics, Amsterdam: North-Holland.
(1978), ‘A Proposal for International Monetary Reform’, Eastern Economic Journal, 4, July– October, pp. 153–9.
(1980), ‘Are New Classical Models Plausible Enough to Guide Policy?’, Journal of Money, Credit and Banking, 12, November, pp. 788–99.
(1982), Essays in Economics, Vol. 3: Theory and Policy, Cambridge, MA: MIT Press.
(1987), Policies for Prosperity: Essays in a Keynesian Mode (ed. P.M. Jackson), Brighton: Wheatsheaf Books.
(1993), ‘Price Flexibility and Output Stability: An Old Keynesian View’, Journal of Economic Perspectives, 7, Winter, pp. 45–65.
(1996a), Full Employment and Growth: Further Keynesian Essays on Policy, Cheltenham, UK and Brookfield, USA: Edward Elgar.
(1996b), Essays in Economics, Vol. 4: National and International, Cambridge, MA: MIT Press.
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