Franco Modigliani was a New-Keynesian economist who won the Nobel Prize in Economics in 1985 for “his fundamental studies of savings and financial markets”. He is best known for his contributions to consumption theory, financial economics, and the theory he developed, called the Modigliani-Miller Theorem of corporate finance.
He was born in Rome, Italy, on 18 June 1918 and moved to the United States at the beginning of World War II. When he was only 13 years old, the sudden death of his father was an event that delayed his studies and affected him so deeply that he had to abandon them for 3 years. Once he had passed this stage, and thanks to his excellent progress, he took the university exam and was able to skip his last year of high school and start his university career at 17.
In his second year at the University of Rome, Franco Modigliani entered a student organisation’s economic essay competition, which he won, and it was at this point that he realised that his interest was in economics even though his family wanted to see him follow in the footsteps of his father who was a paediatrician. The same organisation that had sponsored the prize, I Littoriali Della Coltura, had also helped him make contact with other anti-fascists. His political philosophy moved in that direction.
Because of fascism, his opportunities for a proper education in economics were limited, so he had to continue his education independently and with the help of some economists whom he knew personally and came to value highly, most notably Riccardo Bachi.
Modigliani studied law at La Sapienza University in Rome. After emigrating to the United States, he obtained his doctorate in economics at the New School for Social Research.
Franco Modigliani’s contribution to economics
He taught at Bard College, Columbia University before becoming a professor at the University of Illinois at Urbana-Champaign, Carnegie Mellon University and the Massachusetts Institute of Technology. Modigliani was president of the American Economic Association, the American Finance Association and the American Econometric Society.
He also served as an advisor to Italian banks and politicians, the US Treasury, the Federal Reserve System and several European banks.
Franco Modigliani‘s early contributions were in socialism and centrally planned economies, for which he received an award from the Italian fascist dictator Benito Mussolini. His most notable contributions to economic science include his life-cycle theory of consumption and the Modigliani-Miller Theorem of corporate finance. He also made important contributions to theories of rational expectations and the non-accelerating inflation rate of unemployment.
One of Modigliani’s early contributions to economics was the life-cycle theory of consumption, which implies that individuals save mainly during their early years to pay for their later years.
The idea is that people prefer a relatively stable level of consumption, borrowing (or spending the savings passed on to them). At the same time, they are young, saving during middle age when incomes are high, and spending the savings in retirement. This introduces age demography as a factor that helps determine a Keynesian consumption function for the economy.
Another of his major contributions was the Modigliani-Miller theorem, in cooperation with Merton Miller, which formed the basis of capital structure analysis in corporate finance. Capital structure analysis helps companies determine the most efficient and beneficial ways to finance their businesses through a mix of equity and debt. The Modigliani-Miller theorem argues that if financial markets are efficient, this mix will make no difference to the firm’s value. This theorem would become the basis for much of modern corporate finance.