Volume 121 >> Issue 29 : Wednesday, July 11, 2001

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Book Review

Engaging Economic Adventures

Staff WRITER

In almost any economics textbook, a reader will encounter the work of MIT Institute Professor and Nobel Laureate Franco Modigliani. Developing and testing powerful theories of personal saving behavior and corporate financial policy, Modigliani played a large role in moving economic science from ad-hoc models to firmer foundations. Equally striking is the enduring respect and affection that Modigliani has earned from colleagues and students. In Adventures of an Economist, Modigliani displays his considerable economic insight and shows the wit and compassion that have earned him the love of fellow economists in America, Italy, and the world. This book is delightful reading for anybody with an interest in economic theory or policymaking.

Potential readers should be warned, however, that this book is not quite a traditional autobiography. Modigliani moves quickly back and forth across standard autobiographical material, economic theory, and analysis of postwar economic policy in Europe and the US, and closes with a proposal for Social Security reform. Those who prefer to read autobiographies that have no equations may find some parts of the book tough sailing, but for the rest, Adventures of an Economist makes for rewarding reading.

It is useful to start with a summary of Modigliani’s contributions to economic sciences. The 1985 Nobel award announcement made particular mention of three of his contributions. First came Modigliani’s work on personal saving behavior. Starting with the intuition that saving during the working life is motivated by the goal of maintaining a comparable standard of living during retirement, Modigliani and fellow economist Richard Brumberg developed a well-specified life-cycle model of individual consumption and saving behavior. This model of microeconomic behavior had important implications for the aggregate economy, and in a later series of papers Modigliani outlined and tested these aggregate implications. This link from a well-specified microeconomic model to macroeconomic implications was an important leap forward for economic practice.

The Nobel committee also cited two joint works with Merton Miller in the field of corporate finance. Taken together, these papers moved corporate finance from the testing of ad-hoc models onto firm economic foundations. Prior to the Modigliani-Merton papers, corporate finance focused on assessing the ‘optimal’ financial policies for firms to follow. Researchers paid particular attention to assessing how much firms should pay out as dividends, and what mix of equity and debt firms should use to finance their operations.

The Modigliani-Miller theorems showed that, given perfect markets, investors are indifferent about both types of corporate financial decisions. For instance, if investors can borrow and lend at the same interest rate as the firm, they can undo any change in the firm’s mix of debt and equity by borrowing and lending on their own account. Because investors can costlessly undo a firm’s leverage decisions, these decisions do not affect the firm’s total market valuation. These Modigliani-Miller papers represented a leap forward, incorporating more solid economic reasoning into the analysis of corporate financial behavior.

In addition to these three seminal research papers, Modigliani played a large role in the development of one of the first large-scale macroeconomic models. This model was developed in the 1960s by Modigliani and other academic researchers under the auspices of the Federal Reserve Board, and was the most important macroeconomic model in use at the Fed until the mid-1990s. In his role as a teacher at MIT, Modigliani also trained a long list of prominent economists, including MIT’s own Institute Professor Peter A. Diamond.

Adventures of an Economist gives a picture of the man behind these contributions, and the picture that emerges is one of a witty, caring man whose dedication to truth and to his friends is inspiring. His dedication to economics is also awe-inspiring; pages 20 through 43 of the book are a discussion of Keynesian economics that would not seem out of place in a traditional macroeconomics textbook.

The book is divided into three sections, and the first of these sections comes closest to traditional autobiography. This section describes his upbringing in Rome, where he was born in 1918 and where his father was a prominent pediatrician. After studying law in college, Modigliani was forced by the Fascist persecution of Jews to leave Italy for France and then the United States prior to the Second World War. Arriving in New York City in 1939 with his wife Serena and her father’s family, Modigliani’s first job was as a wholesale dealer of Spanish and Italian-language books. At the same time, Modigliani studied economics under Jacob Marschak at the New School for Social Research, which at that time was a haven for intellectuals forced by fascism and war to flee Europe.

After completing his PhD in economics at the New School, Modigliani taught at Bard and at the University of Illinois. At Illinois during the McCarthy era, Modigliani and the other European faculty were forced from the economics department in a purge led by none other than the famous football player Red ‘The Galloping Ghost’ Grange, who at the time was a trustee of the University. Modigliani was the last of the purged economists to leave Illinois, and he left with a blast that was published in the local newspaper: “Now there will be peace in the Department of Economics: The peace of death!” That Franco Modigliani does not seem ever to have been one to mince words is part of his charm.

From Illinois, Modigliani went to the Carnegie Institute of Technology, where he spent eight years in a department led by future Nobel Laureate Herb Simon. It was during this period that Modigliani and Merton Miller developed their theories that would revolutionize corporate finance. He paints a memorable picture of the Carnegie department during this period: Herb Simon eating the same lunch of American cheese on white bread every day in order to save the time spent deciding what to have. Modigliani came to MIT in 1960, where he has been a central figure in an economics department that includes fellow Nobelists Paul A. Samuelson and Robert M. Solow. From MIT, Modigliani has served as an advisor to the Federal Reserve, the Treasury, and the Italian Central Bank, and the second section of the book, a history of exchange rate policy starting with the collapse of the Bretton Woods era, reflects his wealth of knowledge. At this point Modigliani makes the first of his policy prescriptions, that the persistently high rates of unemployment in Europe must be relieved by old-fashioned Keynesian monetary stimulus.

The third section of the book, entitled ‘Italy and Me,’ is primarily a reflection on Italian economic policy since the 1960s, peppered with reflections on differences between his adopted and his native lands. The most striking part of the section comes when Modigliani relates how, while being interviewed for Italian TV in 1979, he learned of the politically-motivated jailing of a deputy at the Bank of Italy. Modigliani immediately stopped the interview, saying on TV that he would refuse to work further in Italy until the deputy was released and cleared.

Particularly striking are his thoughts on the nature of citizenship; some are deeply moving: “When a state goes against the conscience of one of its citizens, she or he has the right to protest and must have the right to fight against its decisions. Our Fatherland is humanity, friendship, fair play -- values that stem from deep within the conscience of each of us and that the state must respect.” Indeed, for all the economic theory, policy, and equations, the reader will come away from Franco Modigliani’s Adventures of an Economist moved most by his human qualities of compassion, honesty, and wit.