Copyrighted material Preface Acknowledgments. Introduction 1. 1 An American Keynesian 10

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1 Contents Preface Acknowledgments vi viii Introduction 1 1 An American Keynesian 10 2 Transforming the IS-LM Model Sector by Sector 24 3 Consumption, Rationing, and Tobit Estimation: Tobin as an Econometrician 44 4 Portfolio Balance, Money Demand, and Money Creation 63 5 Tobin s q and the Theory of Investment 73 6 Money and Long-Run Economic Growth 90 7 To Improve the World: Limiting the Domain of Inequality Taming Speculation: The Tobin Tax Tobin s Legacy and Modern Macroeconomics 130 Notes 156 Bibliography 166 Index 191 v

2 Introduction An economist s life, in and beyond the ivory tower James Tobin, winner of the 1981 Royal Bank of Sweden Prize in Economic Science in Memory of Alfred Nobel, was the outstanding monetary economist among American Keynesians. He is known to the public for the proposed Tobin tax to curb international currency speculation and to the economics profession for contributions ranging from the Tobit estimator for limited dependent variables and the Tobin separation theorem in portfolio choice through Tobin s q in investment theory to the Nordhaus-Tobin Measure of Economic Welfare (a pioneering work of green accounting ). Tobin vigorously upheld, first against Milton Friedman s monetarism and then against New Classical economics, the Keynesian vision of an active role for government in stimulating output, employment, and growth and in preventing depressions in an economy that was not automatically self-stabilizing. In the first debate with Friedman (see, e.g., the exchange in Gordon 1974), Tobin largely persuaded the economics profession that money demand does respond to interest rates, and both monetary and fiscal policy matter for short-run aggregate demand. In retrospect, reflected Tobin (in Colander 1999, 120), that controversy doesn t look as important as the one between Keynesian economics and New Classical macroeconomics about whether or not the actual economy is best described as a continuous full-employment solution. In Tobin s later years, the mainstream of macroeconomics and monetary economics moved away from his modeling approach toward representative agent models and New 11

3 12 James Tobin Classical macroeconomics, but confidence in economic stability and automatic restoration of full employment has been shaken by the global financial and economic crisis that began in 2007, renewing interest in stability and full employment as things to be achieved rather than to be assumed. Tobin was born on March 5, 1918, in Champaign, Illinois, the son of a social worker and of a journalist who was director of press relations for the University of Illinois Athletic Association. His childhood home was full of books and magazines. Growing up in the Great Depression made a lasting impression on Tobin: I think that a lot of contemporary economists who never had any experience with that catastrophe regard it as some kind of aberration so that they don t have to worry about accommodating it in their theories of macroeconomics. They just dismiss it as something that didn t happen or that they can t explain. But for people who did grow up in the depression, it was an obsession (Tobin in Shiller 1999, 869). Educated at the university s experimental high school (later celebrated for the number of Nobel Prizes won by its graduates), Tobin went to Harvard on a scholarship in 1935, receiving his AB in 1939, MA in 1940 and, after wartime service, his PhD in He went to Washington, DC, in the summer of 1941 to work first in the civilian supply part of the Office of Price Administration and Civilian Supply and then at the War Production Board. He enlisted in the US Navy after Pearl Harbor. In April 1942, he was called to duty, went to school to become an officer in 90 days, and then served as navigator and second in command of the destroyer USS Kearny. Returning to Harvard in January 1946, Tobin completed his dissertation on saving by April 1947, despite a heavy teaching load as a teaching fellow. From 1947 to 1950 he was a junior fellow in Harvard s Society of Fellows, which was meant to be a substitute for a doctor s degree, not a postdoctoral position. But they waived that requirement... for veterans like me, because they could understand that the first thing I wanted when I got back was to get a degree (Tobin in Colander 1999, 119). Tobin s time at Harvard was shaped by reading Keynes s newlypublished General Theory of Employment, Interest and Money (1936) the first economics book Tobin ever read and by contact with such outstanding professors as Alvin Hansen, Wassily Leontief, Joseph Schumpeter, and Edwin B. Wilson (see Tobin 1976a

4 Introduction 13 on Hansen, Tobin 1991b on Schumpeter) and with perhaps even more outstanding economics students such as Paul Samuelson, Lloyd Metzler, Trygve Haavelmo, Robert Heilbroner, and, after the war, Robert Solow and Hyman Minsky. While Tobin was a junior fellow, he met a beginning Harvard graduate student and future Nobel laureate, Robert Solow, later his closest friend in his generation of economists: Jim must have finished his Ph.D. thesis by then, and would soon decamp for Yale, neither the first nor the last in a series of humongous Harvard blunders (Solow 2004, 657). In contrast to his sense of equality with Solow, Tobin was always somewhat in awe of Solow s MIT colleague, the Nobel laureate Paul Samuelson. Tobin spent the last year of his Harvard junior fellowship across the Atlantic at the other Cambridge, visiting Richard Stone s Department of Applied Economics (DAE), writing econometric papers about food demand and about how to estimate the demand for rationed goods, and befriending Harry Johnson (see Tobin s reminiscences of that year in Tobin 1978c, an obituary of Harry Johnson). Herman Wouk s novel The Caine Mutiny (1951) offers a glimpse of Tobin training to be a naval officer (and perhaps the source of the name of the Tobit estimator): A mandarin-like midshipman named Tobit, with a domed forehead, measured quiet speech, and a mind like a sponge, was ahead of the field by a spacious percentage. Courted by many US economics departments while in Harvard s Society of Fellows, Tobin joined Yale University in New Haven, Connecticut in 1950: Yale made the best offer, associate professorship right away (Tobin in Shiller 1999, 874). His wife Betty (the former Elizabeth Ringo, an economics student he met in 1946) had said she d go anyplace except New Haven, but we went to New Haven and she loved it (Tobin in Colander 1999, 119). He was promoted to full professor in 1955 (the year the American Economic Association awarded him the John Bates Clark Medal for the best US economist under 40 years old) and to Sterling Professor of Economics in 1957, the year before his presidency of the Econometric Society. Summers were spent in Wisconsin, at this family place which I have actually gone to all my life, from the time I was a small child, a baby indeed, to now. It s a gathering point not only for our family and children and grandchildren but

5 14 James Tobin for the extended families, my brother and cousins and their families, and for succeeding generations... It happened that my wife, Betty, whom I met in Cambridge, Massachusetts, in 1946, far from Wisconsin, was from Wisconsin, too, and had grown up not too far from the place I had gone to. (Tobin in Shiller 1999, 890) Tobin retired as Sterling Professor Emeritus in 1988, but continued to teach undergraduate courses for another decade, and lived in New Haven with Betty, in the same house they had bought in 1951, until his death on March 11, He was intellectually active to the end: In fact, wrote Paul Krugman (2002) in his obituary of Tobin, I was on a panel with him just last week, where he argued strongly that the current situation called for more domestic spending, not more tax cuts. In 1953, Jacob Marshak and Tjalling Koopmans, the leaders of the Cowles Commission for Research in Economics, invited Tobin to move to the University of Chicago to direct the Cowles Commission, which was then the world s foremost center of econometrics and mathematical economics but was on uneasy terms with the rest of the university s economics department (see Shiller in Colander 1999, 130). Tobin (in Shiller 1999, 875) recalled, Although the Cowles appointment carried with it a professorship in the University of Chicago economics department, when I asked the chairman [Theodore Schultz, a future Nobel laureate] if the department would have been interested in me without the Cowles connection, he said No. I felt bad when I phoned Tjalling to turn down the offer. To my surprise he didn t seem disappointed. He immediately asked me if Yale might be interested in his spending his sabbatical in at Yale... Tjalling came, the negotiations to move the commission to Yale started right away, and in 1955 the Cowles Foundation was established with me as its director. Two decades later Koopmans was Yale s first Nobel laureate in economics. Tobin directed the Cowles Foundation for seven years and chaired Yale s Department of Economics for six years. Arthur Okun, who went on from Yale to chair the President s Council of Economic Advisers and co-founded the Brookings Papers on Economic Activity,

6 Introduction 15 was particularly close to Tobin and to his approach to macroeconomics (see Okun 1981, which was published posthumously). Tobin (in Colander 1999, 120) recalled that what people meant by the Yale school... is identified with my, and Art Okun s, macroeconomic and monetary views and teachings. (The importance of the late Art Okun, and the loss to all economists of his premature death, can t be exaggerated.) Others at Yale whom Tobin regarded as sympathetic to my views in macroeconomics were Ray Fair; Bill Brainard, who was a partner in developing a lot of what I did in the models we were just discussing; Bill Nordhaus, who was a student of mine, and a collaborator of mine not so much in macro but in other things like MEW (the measure of economic welfare); and Bob Shiller, who s, again, not a student of mine or a collaborator, but who thinks about macroeconomic things in similar ways to me and Bill Brainard. (Tobin in Colander 1999, ; see Brainard and Tobin 1968, Tobin and Brainard 1977, Brainard, Nordhaus, and Watts 1991, Fair , 1977, 1979, 1984, 1994, 2004, Nordhaus and Tobin 1972, Shiller 1989, 1999, 2000). All of these were part of the Cowles Foundation a.m. coffee group, but it includes other people, too: Chris Sims, who s an advocate of real business cycles; Martin Shubik, a very interesting guy, but I don t think of him as a member of any particular school except his own; John Geanakoplos, who is sympathetic to my macro views but who wants to reconcile them to Arrow/Debreu [general equilibrium]; Herb Scarf, a math theorist; and T. N. Srinivasan, a tough neoclassical economist. (Tobin in Colander 1999, 120) William Fellner, an earlier Yale colleague, was a good friend of Tobin despite very different approaches to macroeconomics (see Fellner 1946, 1976). Tobin s academic career of teaching and research experienced only one major interruption. His work on a major treatise on monetary theory, comparable in scale to Don Patinkin s Money, Interest and

7 16 James Tobin Prices (1956), was halted by his service for 20 months in 1961 and 1962 on President John F. Kennedy s Council of Economic Advisers. On leave from Yale, Tobin put aside the manuscript, which eventually became Money, Credit and Capital (Tobin with Golub 1998). Robert Solow, who took leave from MIT to join the council s staff, recalled, Jim Tobin was clearly the intellectual leader of the Kennedy Council (Solow 2004, 658). During the 1960 presidential campaign, the Kennedy Democrats criticized the incumbent Republican administration for not promoting economic growth sufficiently. Tobin, who, like the Kennedy brothers, had been a Harvard undergraduate in the 1930s, wrote several memoranda and position papers on economic growth to the Kennedy campaign in the summer of 1960 (despite his informing Ted Sorenson that he preferred Adlai Stevenson for the nomination). These memoranda are the basis of a July 1960 New Republic article entitled Growth through Taxation (reprinted in Tobin 1966b) in which he called for a combination of easy monetary policy (to stimulate investment) and tight fiscal policy (to control inflation), using tax revenues to increase public saving. But, he said, [Kennedy] didn t quite want to do that to raise taxes to increase the rate of growth! (Tobin in Shiller 1999, 882). One of Tobin s recommendations was to limit tax deductions for advertising. When his nomination to the council came up for Senate confirmation, recalled Tobin (in Shiller 1999, 882), One of the senators on the committee asked me about this proposal which he regarded as a really terrible thing. And so, I was in a little trouble because of this idea, but they weren t that worried about who was on the council in those days. Tobin reminisced that when President Kennedy asked him to join the council, I said, Well I don t think that I am the type for that; I m an ivory-tower economist, and he said, Well, that s the best kind, I m going to be an ivory-tower president, and I said, Well, that s the best kind (in Shiller 1999, , cf. Colander 1999). Under the chairmanship of Walter Heller, the Kennedy Council of Economic Advisers propounded the New Economics, a Keynesian approach that saw an active role for government in both stabilizing the economy and raising the rate of economic growth (see Tobin 1974b, Tobin and Weidenbaum, eds. 1988, and Bernstein 2001). Contrary to Tobin s 1960 New Republic article, the Kennedy Council became associated with aggregate demand stimulus through a tax cut (as in Tobin s New Republic article Tax Cut Harvest in March 1964).

8 Introduction 17 Tobin s work at the council was reflected in his 1963 Ely Lecture to the American Economic Association on Economic Growth as an Objective of Government Policy and in magazine articles collected with that lecture in his book, National Economic Policy (1966). But even that collection of writings on public policy, mostly in non-academic magazines, was published by a university press, as was his volume of reflections on The New Economics One Decade Older (1974). After leaving Washington, Tobin continued as a consultant to the council until When accepting Tobin s resignation from the council to return to Yale, President Kennedy wrote, I remember your protesting, in our telephone conversation prior to your appointment, that you were an ivory tower economist. If so, you have convincingly demonstrated that the ivory tower can produce public servants of remarkable effectiveness. Your ideas on domestic policies for stability and growth, and on many other issues have been lucid and reasoned, and your advocacy of them has been forceful and persuasive. I have both enjoyed and benefited from our exchange, and I wish to express my appreciation for your dedicated service. The impact of your contribution will long be felt in the economic policy of my Administration... Your advice, whether from within or without the Government, will always be received with interest and respect in this Administration. (Kennedy to Tobin, July 12, 1962, Tobin Papers 2004-M-088, Box 7, Folder: Resignation Letter) The next document in the folder is a telegram from Robert F. Kennedy after the assassination, reporting that the president s body would be resting in the East Room of the White House. Overview Self-identification as a Keynesian (later as Old Keynesian) was central to Tobin s view of himself as an economist. Keynes s legacy has been intensely contested among many claimants, so what Tobin meant by accepting and embracing that label is central to understanding Tobin as an economist (see Chapter 1, An American Keynesian ). Influenced by John Hicks as well as by Keynes, Tobin helped Alvin Hansen present Keynesian economics through the IS-LM framework

9 18 James Tobin of equations and diagrams, and then devoted his career to developing optimizing microeconomic foundations for each sector of the IS-LM framework with consistency between stocks and flows (Chapter 2, Transforming the IS-LM Model Sector by Sector ). In the words of Paul Krugman (2002), Tobin took the crude, mechanistic Keynesianism prevalent in the 1940 s and transformed it into a far more sophisticated doctrine, one that focused on the tradeoffs investors make as they balance risk, return and liquidity. In contrast to later New Classical methodology that linked markets and sectors through the budget constraint of an optimizing representative agent, Tobin modeled optimization sector by sector, emphasizing stock-flow consistency and imposing plausible restrictions on the partial derivatives of demand functions, avoiding any assumption of a continuously clearing labor market. The first sector of the IS-LM framework that Tobin developed was consumption and saving, the S of the IS curve. His dissertation was on savings decisions (stressing asset holdings as a determinant of saving), and his early articles, which brought him the John Bates Clark Medal in 1955 and the presidency of the Econometric Society, were on savings decisions and on modeling consumer demand (Chapter 3, Consumption, Rationing and Logit Estimation: Tobin as an Econometrician ). As late as 1968, after more than a decade as a leading monetary economist, it was as an expert on the consumption function that Tobin contributed to the International Encyclopedia of the Social Sciences. Tobin s articles from 1956 onward, analyzing demand for money as a means of payment and as an asset in the context of multi-asset portfolio equilibrium and the creation of money by the banking system (liquidity preference and money supply, the L and M of the LM curve), were of fundamental importance for monetary economics (Chapter 4, Portfolio Balance, Money Demand, and Money Creation ), and always kept in mind the transmission mechanism for monetary policy to affect the real economy. Beginning in 1968, Tobin and his Yale colleague and former graduate student, William Brainard, introduced Tobin s q (the ratio of the market value of capital assets to their replacement cost) as the determinant of investment (the I of the IS curve) and thus as the channel through which monetary policy acts on the real economy, a concept with roots in Keynes s writings (Chapter 5, Tobin s q and the Theory of Investment ).

10 Introduction 19 If monetary policy affects investment decisions, it can have lasting, non-neutral effects on capital stock, productive capacity, and real output, even in the long-run with full employment, as Tobin argued in papers introducing money into long-run models of economic growth (Chapter 6, Money and Long-Run Economic Growth ). He was also a key figure in the creation of the neoclassical growth model and, with his Yale colleague and former student, William Nordhaus, a pioneer in what is now called green accounting, the creation of a Measure of Economic Welfare that adjusted economic growth figures for changes in environmental quality, leisure, traffic congestion, crime, and other factors to obtain a clearer sense of how living standards had changed. Tobin s view, shaped by the Great Depression of the 1930s, of economics as a way to improve people s lives, rather than primarily to solve intellectual puzzles, was also expressed through his sweeping proposals for diminishing inequality and eliminating severe poverty in the United States (Chapter 7, To Improve the World: Limiting the Domain of Inequality, which takes its subtitle from the title of Tobin s Simons Lecture). His proposal for international monetary reform, to inhibit international speculative flows of hot money and to protect the leeway for domestic stabilization policies by taxing currency trades, are better known to the general public than his domestic proposals, and have been taken up by groups who do not share Tobin s commitment to free trade in goods and services (Chapter 8, Taming Speculation: The Tobin Tax ). Chapter 9 ( Tobin s Legacy and Modern Macroeconomics ) examines the relationship between Tobin s economics and the mainstream of modern macroeconomics and monetary economics, exploring the differences in the methodology and the reasons why the mainstream moved away from Tobin s vision, but also finding that much of Tobin s contribution remains relevant, notably his analysis of economies with a corridor of stability, that self-adjust for small demand shocks but require active stabilization policy to cope with exceptionally large shocks.

11 1 An American Keynesian Introduction In September 1936, when James Tobin was an 18-year-old sophomore taking Principles of Economics (Ec A) at Harvard, his tutor, Spencer Pollard (a graduate student who was also the instructor of Tobin s Ec A section) decided that for tutorial he and I, mainly I, should read this new book from England. They say it may be important. So I plunged in, being too young and ignorant to know that I was too young and ignorant to begin the study of economics by reading Keynes s The General Theory of Employment, Interest and Money (Tobin 1988, 662). Pollard was right: the book did turn out to be important, not least for its lasting role in shaping Tobin s intellectual development. Tobin (1992, 1993) remained proud to call himself an Old Keynesian in contrast to New Keynesian, New Classical, and Post Keynesian, and, when Harcourt and Riach (1997) edited A Second Edition of The General Theory, it was fitting that they invited Tobin (1997) to contribute the overview chapter, with the first part of the chapter written as J. M. Keynes. 1 Although Sir John Hicks (1935, 1937, 1939) and Irving Fisher also influenced Tobin 2, his approach to economics was always most deeply shaped by Keynes and by Tobin s experience growing up during the Great Depression of the 1930s. Throughout his career, Tobin was concerned with developing macroeconomic theory that would be relevant for stabilization policy to prevent another depression and to improve people s lives by promoting growth and stability rather than with analytical 10

12 An American Keynesian 11 problem-solving for its own sake. The Great Depression was associated with the breakdown of the US banking system and with Keynes s argument that depression due to inadequate effective demand was a distinctive problem of a monetary economy as opposed to a barter economy. More than any of the other leading American Keynesians of his generation, such as Nobel laureates Paul Samuelson, Robert Solow, Franco Modigliani, and Lawrence Klein, Tobin concerned himself with the functioning and malfunctioning of the monetary system, telling David Colander (1999, 121) I differed from that group [American Keynesians in the 1950s] in that I taught that monetary policy was a possible tool of macroeconomic policy and that to neglect it was a mistake. Tobin set himself apart from Keynes s disciples at Cambridge University (such as Joan Robinson, Richard Kahn, and Nicholas Kaldor) and their Post Keynesian allies in the United States because he objected to throwing away the insights of neoclassical economics (in Colander 1999, 121). Even his late-career mellowing toward the British side of the Cambridge capital controversies was subtitled, A Neoclassical Kaldor-Robinson Exercise (Tobin 1989b). But he also stood aside from New Keynesians: If it means people like Greg Mankiw, I don t regard them as Keynesians. I don t think they have involuntary unemployment or absence of market clearing, just nominal wage and price stickiness, in contrast to Keynes s insistence that nominal wage and price flexibility could not be relied upon to eliminate unemployment. (Tobin in Colander 1999, 124; Keynes 1936, Chapter 19). Tobin thus staked a distinctive claim to Keynes s contested heritage. He reiterated this claim to be a Keynesian throughout his career, using Keynes s term liquidity preference in the title of his article on demand for money as an asset (Tobin 1958a), linking the proposed Tobin tax to restrain international currency speculation to Keynes s proposed turnover tax to curb stock market speculation (Keynes 1936, 160; Tobin 1984a), and building his theory of investment around Tobin s q (Brainard and Tobin 1968, Tobin and Brainard 1977), a concept closely related in both substance and notation to the Q of Keynes s Treatise on Money (1930), notation that Keynes had chosen because of Alfred Marshall s quasi-rents.

13 12 James Tobin The central propositions of Keynes s General Theory according to Tobin In How Dead is Keynes? Tobin (1977a) summarized the central message of Keynes s General Theory in four propositions and argued that reports of the death of Keynes, like those of the demise of Mark Twain, were much exaggerated: None of the four central Keynesian propositions is inconsistent with the contemporary economic scene here or in other advanced democratic capitalist countries. At least the first three fit the facts extremely well. Indeed the middle 70s follow the Keynesian script better than any post-war period except the early 60s. It hardly seems the time for a funeral. (460) What Keynes meant to convey as his central message is hotly contested, with a huge literature emphasizing nominal wage stickiness, or discretionary policy, or fundamental uncertainty, or rejection of Say s Law, or the spending multiplier. But while Tobin s four central Keynesian propositions do not settle the controversies over what Keynes meant (let alone the controversies over whether Keynes was, in some sense, right), they show what being a Keynesian meant to Tobin. Tobin s first central Keynesian proposition was that In modern industrial capitalist societies, wages respond slowly to excess demand or supply, especially slowly to excess supply, so that over a long short run fluctuations in aggregate demand affect real output, not just prices. A corollary of this was the second proposition: the vulnerability of economies like ours to lengthy bouts of involuntary unemployment. The only distinctively Keynesian aspect of Tobin s first two central Keynesian propositions was the insistence on the phenomenon of involuntary unemployment, an excess supply of labor in a non-clearing labor market. Replace involuntary unemployment with high unemployment in the second proposition, and the two propositions would be acceptable to David Hume in 1752, Henry Thornton in 1802, Alfred Marshall in 1887, or Milton Friedman (1968). Tobin (1977a, ) pointed to the high unemployment since 1974 as supporting evidence, insisting that the increased unemployment was indeed involuntary: People willing

14 An American Keynesian 13 to work at or below prevailing real wages cannot find jobs. They have no effective way to signal their availability. By contrast, in Friedman (1968) with adaptive expectations and the expectations-augmented Phillips curve, and in Lucas (1981a) with the monetary-misperceptions version of New Classical economics, the labor market clears, but the labor demand curve shifts as workers are fooled by monetary shocks into misperceiving the real wage. Tobin s first two Keynesian propositions summarized widely shared views (although New Classical economists would be troubled by the very idea of involuntary behavior), and came to textbook Keynesianism from Chapter 2 of Keynes (1936), in which Keynes discussed the two classical postulates of the labor market. Keynes accepted the first classical postulate that the real wage is equal to the marginal product of labor (that is, firms are competitive and on the labor demand curve) but rejected the second one that the utility of the real wage is equal to the marginal disutility of labor (that is, labor is on the labor supply curve). Although Keynes s Chapter 2 provided an account of why staggered contracts and concern of workers with relative wages could make nominal wages sticky downwards without any money illusion (a precursor of the more formal modeling of Taylor ), the textbook version and Tobin s first two Keynesian propositions were consistent with the claim that Keynesian analysis, however practically important, was theoretically trivial: just a classical system with a sticky nominal wage rate. Emphasizing slow adjustment of prices and money wages implied viewing Keynesian unemployment as a disequilibrium situation, a short-run phenomenon of transition periods, rather than accepting Keynes s claim to have shown the possibility of equilibrium with involuntary unemployment (excess supply of labor). Writing as J. M. Keynes for A Second Edition of The General Theory, Tobin (1997, 7) held that Keynes (1936, Chapter 2) leaned too far to the classical side, as I learned shortly after the book was published, thanks to the empirical studies of [John] Dunlop and [Lorie] Tarshis. If the first classical postulate were correct, then we would expect real wages measured in terms of labour s product rather than workers consumption to move counter-cyclically. However, Dunlop and Tarshis found that product-wages were, if anything, pro-cyclical. This is not a fatal flaw

15 14 James Tobin in the general theory; quite the contrary: my essential propositions remain unscathed.... If increases in aggregate demand can raise employment and output without diminishing real wages, so much the better!... Nothing is lost by recognizing that imperfect competition and sluggish price adjustment may result in departures from marginal cost pricing, especially in short runs. (See articles by Dunlop, Tarshis, Keynes, and Ruggles reprinted, together with Tobin 1941, in Dimand 2002, Volume VIII.) Tobin s third central Keynesian proposition was that: Capital formation depends on long run appraisals of profit expectations and risks and on business attitudes toward bearing the risks. These are not simple predictable functions of current and recent economic events. Variations of the marginal efficiency of capital contain, for all practical purposes, important elements of autonomy and exogeneity. (1977a, 460, cf. Keynes 1936, Chapter 12, The State of Long-Term Expectation ) This emphasis on autonomous shifts of long-period expectations (Keynes s animal spirits ) rejected the rational expectations hypothesis introduced into macroeconomics in the 1970s by Robert Lucas (1981a) and Thomas Sargent and Neil Wallace (1976), as well as the endogenous, adaptive expectations of Friedman (1968). Tobin s emphasis on fluctuations in long-period expectations of future profits fit with a view that the Wall Street crash of October 1929 mattered for investment and the Great Depression (the market value of equity, the numerator of Tobin s q, is the present discounted value of expected future after-tax net earnings), in contrast to Friedman and Schwartz (1963), who reinterpreted the Great Depression as a Great Contraction of the money supply resulting from mistaken Federal Reserve policy. Tobin s third central Keynesian proposition also undermined attempts (for instance by Minsky 1981 and Crotty 1990) to contrast an allegedly neoclassical Tobin s q, supposedly based on a known probability distribution of underlying fundamental variables, with a more truly Keynesian approach that recognized fundamental uncertainty and exogenous shifts in long-period expectations. The fourth central Keynesian proposition in Tobin (1977a), following Chapter 19 of The General Theory, held that Even if money

16 An American Keynesian 15 wages and prices were responsive to market excess demands and supplies, their flexibility would not necessarily stabilize monetary economies subject to demand and supply shocks. This proposition, advanced vigorously by Tobin (1975, 1980a, 1992, 1993), placed the Keynesian challenge to what Keynes termed classical economics on a level of core theory. Keynesianism, as interpreted by Tobin, could not be dismissed as nothing more than the empirical observation (or arbitrary assumption) that money wage rates are sticky downwards. Even if prices and money wages responded promptly, the economy might fail to automatically readjust to potential output after a large negative demand shock and might require government intervention to restore full employment. Making money wages more flexible by eliminating trade unions, minimum wage laws, and unemployment compensation might just make things worse. Tobin s fourth Keynesian proposition, and the emphasis on Chapter 19 as crucial to understanding the message of Keynes s General Theory, were central to Tobin s Keynesianism: involuntary unemployment might be a disequilibrium phenomenon, but the system might not have any mechanism to move it back to the full employment equilibrium after a sufficiently large negative demand shock. Tobin stressed Keynes s Chapter 19 on changes in money wages rather than Chapter 17 on the peculiar properties of money : its zero elasticity of production and zero elasticity of substitution (in contrast to Tobin s view of money as an imperfect substitute for other assets, and of an endogenous money supply with a finite elasticity of supply). Tobin (1977a, 460) endorsed Keynes s challenge to accepted doctrine that market mechanisms are inherently self-correcting and stabilizing. Unlike his first three central Keynesian propositions, Tobin did not claim empirical support for the fourth proposition: since money wages and prices did not in fact respond rapidly to excess demands and supplies, there could not be much direct evidence of what would happen in that counterfactual situation. The case for the fourth proposition had to be made, as in Tobin (1975), at a theoretical level. It was a case that he only made explicitly and formally from the 1970s onward, when Keynesianism was under challenge from natural rate of unemployment theories, first the monetarism of Friedman (1968), and then the New Classical economics of Lucas (1981a), which claimed the demand stimulus could increase employment and output only by tricking workers into accepting a lower real

17 Index adaptive expectations, 13, 14, 16 adding-up constraint, 19 20, 23, 39 aggregate consumption, aggregate demand, 1, 6, 12, 14, 22, 41 2, 48, 58, 62, 72, 86, 107, 115, 123, 142 3, 145 6, 153, 162n10 Aid to Families with Dependent Children (AFDC), Allais, Maurice, 18, 35, 65 Allais-Baumol-Tobin square root rule, 19, 24 5, 35, 60, 65, 157n9, 164n27 American Keynesians, 10 23, 25 9, 131 Ando, Albert, 59, 139 animal spirits, 14, 89 applied general equilibrium (AGE), 38 asset markets, 18, 20, 24 5, 38 9, 43, 58 9, 63, 69, 73 4, 85 7, asset prices, 25, 34 6, 73, 89 assets, 33, 34, 64 Authers, John, 74 automated payment transaction tax, 128 Bagehot, Walter, 116 balanced budget multiplier, 28 banking system, 8, 11, 78, 143 Barten, Anton, 54 Basmann, Robert, 54 Baumol, William, 18, 35, 65 Bhagwati, Jagdish, 114, Black, John D., 46 Bliss, Chester, 56 bonds, 32, 34 5, 57, 65 8, , 146 Borch, Karl, 33 Boulding, Kenneth, 63 Brainard, William C., 5, 8, 20, 34, 38, 59, 64, 85, 86, 88, Brown, A. J., 48 Brumberg, Richard, 139 Brunner, Karl, 36 7, 64 Bruno, Ryan, 22, 103, 154 Bryce, Robert, 82, 135 budget deficits, 98 Buiter, Willem, 20, 44, 65, 68, 90 1, , business cycles, 39, 40, 46, 60, Cambridge University, 11, 51 Canadian inter-departmental econometric model (CANDIDE), 148 capital account liberalization, 122 3, 125 capital asset pricing model (CAPM), 19 capital controls, 121 2, 124 capital flows, 36, 43, 113, , 153 capital formation, 14, 91 cash, 65 6 cash transfers, 109 Champernowne, David, 17 Chicago School, 64, 65, 74, 109, 110 civil rights movement, 106 Clark, John Maurice, 26 classical economics, 15, 16, 22 Cloward, Richard, 108 Colander, David, 11 commercial banks, 69 72, 141 computable general equilibrium (CGE), 38 computing technology, 47 consumer saving, 45, consumption, 38 consumption decisions, 23, 30, 49, 55 6, 62 consumption function, 8, 18, 29 31, 47, 48, 49, 55, 61, consumption theories, 30 Cooper, Richard, 122 coordination problem, 20, 23, 39, 60,

18 192 Index Cowles Commission for Research in Economics, 4, 5, 33, 34, 47, 56, 58, 59, 147 Crotty, James, 88 Crum, William Leonard, 46 currency, 92 3 markets, speculation, 1, 11, 86, 88, 115, 118, 127, 128. see also Tobin tax tax on trades, 1, 11, 74, Cyprus, 126 Dahl, Robert, 106 Davidson, Paul, 118 debt-deflation process, 21 debt neutrality, 50, 164n26 deflation, 41, 133, demand shocks, 21 3 Department of Applied Economics (DAE), Cambridge University, 3, 51 Dimand, R. W., 14, 17, 22, 56, 59, 77, 79, 83, 84, 116, 135, 138, 149, 150, 154 Directly Unproductive (DIP) rentseeking lobbying, 122 discrimination, 106, 111 disequilibrium dynamics, 21, 23 doctoral dissertation, 48 50, 63, 138 Dolde, Walter, 50 Domar, Evsey, 91 Dornbusch, Rudiger, Drazen, Allan, 150 Duesenberry, James, 29 Durbin, James, 51 Dynamic Aggregative Model (Tobin), 90 6 dynamic stochastic general equilibrium (DSGE) models, 71, 160n2 econometrics, Econometric Society, 8 economic activity, 85 7 economic growth, alternative money growth rules, 98 9 dynamic aggregative model, 91 5 government policy and, inflation and, models of, 9 money and, 95 8 steady-state, 104 5, 149 economic stability, 2 economic system, as self-adjusting, 20 3 efficiency-wage theory, 152 Eichengreen, Barry, 126 empirical economics, 44 endogenous money, 15, 18, 35, 72 euro, 117, 125, 126, 128 European Central Bank, 126 European Monetary Union (EMU), 126 exchange rates, 115, , 125, 127 expansionary monetary policy, Fair, Ray C., 5, 41, 59 Family Allowance Plan, Farmer, Roger, 133 Farrell, Michael, 51, 56, 57 Federal Reserve-MIT-Penn model (FMP), 38, 59 Feige, Edgar L., 128 Feldstein, Martin, 33 Fellner, William, 5, 27, 63 fiat money, 39, 98 financial crises, 119, 123, 126, 128 9, 131 financial markets, 115, , fiscal policy, 1, 6, 17, 27, 100 Fischer, Stanley, 97, 123, 150 Fisher, Irving, 10, 18, 21, 29, 30, 49, 64, 65, 87, 133, 140, , 157n5, 160n6 flash crash, 128 food demand study, 45, 47, 50 5, 58 foreign direct investment, 127 Freedom Summer, 106 Free Trade Agreement of the Americas (FTAA), 120 Frickey, Edwin, 46 Friedman, Milton, 1, 12 14, 16, 17, 30, 33, 63 6, 98, 107, 109, 110, 150, 151, 163n22 Friedman-Phelps expectationsadjusted Phillips curve, 146

19 Index 193 full employment, 2, 9, 15, 21 2, 42, 43, 107, 112, 134 Geanakoplos, John, 5 general equilibrium, 38 44, 58 61, 71, General Equilibrium Approach to Monetary Theory (Tobin), 24, 34, 37 8, 44, 58 61, 131, General Theory of Employment, Interest and Money (Keynes), 2, 10, 12 16, 23, 26 7, 55, 58, 74 7, 89, 101, Germany, 126 Geweke, John, 40 global capital flows, global currency, global economy, global financial crisis, 2, 128 9, 131, 147 globalization, 114, Goldberger, Arthur, 30, 57 Golden Rule literature, 99, 100 Golub, Stephen S., 6, 18, 27, 35, 64, 71, 74 5, 76, 85, 91, 140, 141 Goodhart s Law, 71, 151 government bonds, 68 economic growth as objective for, role of, 1, 6 government budget constraint, 39, 98, 149 Granger, Clive, 59 Great Depression, 2, 9, 10, 11, 14, 24, 43, 49, 61 2, 73, 89, 115, 133 6, 142, 151 Greece, 126 green accounting, 1, 9 Greenspan, Alan, 86 7 growth theory, 90 5, Grunfeld, Yehuda, 86 7 guaranteed minimum income, 109, 111 Haavelmo, Trygve, 3, 47 Hansen, Alvin, 2, 7, 16, 24, 26, 27, 28, 30, 48, 58, 135 6, 138 Harris, Seymour, 24, 27 Harrod, Roy F., 91 Harvard University, 2 3, 45 8 Hayashi, Fumio, 31, 86 Hayek, Friedrich A., 107, 135 Heilbroner, Robert, 3 Heller, Walter, 6 Hendry, David, 53 Herrnstein, Richard, 109, Hicks, John R., 7, 10, 18, 32, 43, 48, 69, 137 8, 159n4 Hicks-Hansen diagram, 26, 48, 58, 138 high-frequency computerized trading, 128, 129 household survey data, 52, 56, 58, 61 Hume, David, 12, 64 Huntington, E. V., 45 Iceland, 126 imperfect information, 162n11 income, 50 income elasticity, 54 income redistribution, 111 inequality, inflation, 71, 97 9, 103 4, 146, 149, 150, 151, 154 intellectual property rights, 122 interest-elasticity of transactions, 65 6 interest rate, 24, 31 5, 66, 72, , 151 international currency transactions, 74, International Monetary Fund (IMF), 121, 123, 127 international monetary system, investment, 18, 31, 142 investment decisions, 8 9, 19, 66 9, investment function, 24, 31, 97, 157n6 investment theory, see also Tobin s q IS curve, 29 31, 65 6 IS-LM framework, 7 8, 69, 72, 142 3, 157n11, 162n17 Hicks-Hansen diagram, 26, 48, 58, 138 microeconomic foundations for, Mundell-Fleming open economy, 125 6

20 194 Index IS-LM framework continued short-run, 149 Tobin s analysis of, transforming, Italy, 126 Jencks, Christopher, 111 John Bates Clark Medal, 63 John Danz Lectures, 130, Johnson, Harry G., 3 Kahn, Richard F., 11 Kaldor, Nicholas, 11, 91 Katona, George, 55 6 Kennedy, John F., 6, 7 Keynes, John Maynard, 2, 10, 11, 28 9, 62, 130, 133, 139 General Theory of Employment, Interest and Money, 12 16, 23, 26 7, 55, 58, 74 7, 89, 101, 130, 132, lectures by, 82 5 liquidity preference, 32 Q of, 76 9, 82 5 speculative motive, 31 2, 66 Treatise on Money, 11, 26, 71, 76 9, 85, 89 Keynes effect, 23 Keynesian economics, 1, 7 9 central propositions of, erosion of influence of, Klein, Lawrence, 11, 47, 48, 58, 131 Klevorick, Alvin, 53 knife-edge equilibrium, 91 2 Koopmans, Tjalling, 4, 59 Krugman, Paul, 4, 8, 113, 115, 121 Kydland, Finn, 102 labor demand curve, 13 labor markets, 13, 23, 112 Latin Monetary Union, 116 Laughlin, J. Laurence, 65 Leamer, Edward, 53, 59 Leijonhufvud, Axel, 153 Leontief, Wassily, 2, 29, 47, 87 LeRoy, Stephen, 134 Levhari, David, 150 life-cycle hypothesis, 38 liquidity/money (LM) curve, 31 8, 63, 65 6 see also IS-LM framework liquidity preference, 18, 19, 31 4, 48, 66 9, 93, 140, 142 see also money demand Liu, T. C., 60, 61 long-run expectations, 14 Lucas, Robert, 14, 16, 38, 42, 59, 102 3, 131, 147, 152 macroeconomic models, 44 macroeconomic theory, 10 11, 38 42, Magnus, Jan, 52, 53, 54 market, as self-correcting, 15 Markowitz, Harry, 32 3, 67, 68, 140 Marschak, Jacob, 4, 58 9 Marshall, Alfred, 12 mathematical statistics, 46 7, 56 McGovern, George, 111 McKinnon, Ronald, 126 means testing, Meltzer, Alan, 36 7, 160n4 Metzler, Lloyd, 3 microeconomics, microeconomic theory, 31 8, Minsky, Hyman, 3, 21, 87, 132 Mishkin, Frederic, MIT-Penn-SSRC model (MPS), 38, 59 Modigliani, Franco, 11, 38, 59, 131, monetarism, 1, 146, 149, 160n4 monetary economists, Monetary Equilibrium (Myrdal), monetary modeling, monetary policy, 1, 6, 8 9, 17, , monetary theory, 64 5, 69 72, 73, 143 6, Monetary Theory and Fiscal Policy (Hansen), money, 34, 37 alternative money growth rules, 98 9 creation, 63, 69 72, 98, 141, 154 economic growth and, 95 8 endogenous, 15, 18, 35, 72 fiat, 39, 98 theory of, 18, 64 5, 69 72, Money, Credit and Capital (Tobin with Golub), 6, 64, 141

21 Index 195 Money and Economic Growth (Tobin), 91 money demand, 8, 18 20, 31 5, 63, 65 9, , 142, 154 money illusion, 29 money market equilibrium, 24 money supply, 15, 18, 35 7, 71, 72, 97, 141, 142, , 151 money wages, 13, 15, 20 1, 29, 66, 96 7, 126, 131 4, 152 3, 161n9 Morgan, Mary S., 52 Mosak, Jacob, 58 multi-asset model, 20 Multilateral Agreement on Investment (MAI), 120 multiple regression analysis, 57 Mundell, Robert, 114, 116, 125 8, 149 Mundell-Tobin effect, 149, 150 Murray, Charles, 109, Myrdal, Gunnar, 75 6, 79 82, 84 5, 158n2 Nagatani, Keizo, 21 natural rate of unemployment, 15, 23 near-money demand, 31 2 negative demand shocks, 15, 21 3, 40 negative income tax (NIT), neoclassical growth model, 9, 93 4 New Classical economics, 1 2, 8, 10, 13 16, 40 1, 44, 131, 133, 146 8, 151 2, 162n11 New Economics, 6 new growth literature, New Jersey Negative Income Tax Experiment, New Keyenesians, 10, 102, 131, 152 nominal wages, 11 13, 38, 126, 134, 152 non-accelerating inflation rate of unemployment (NAIRU), 146 7, 164n28 Nordhaus, William D., 5, 9 Nordhaus-Tobin Measure of Economic Welfare, 1, 9 numerical general equilibrium (NGE), 38 Okun, Arthur, 4 5, 37, 41 Old Keynesians, 10, 23, 24, 38 42, 85, 106, overlapping generations (OLG) models, 20, 146 8, 150, 159n5 Papademos, Luca, 126 Patinkin, Don, 5 6, 21 2, 150, 151 Phelps, Edmund, 98 9 Phillips curve, 13, 146 physical capital, 92 Pigou, A. C., 21, 134, 154, 162n10 Pigou-Haberler real balance effect, 21, 41 2 Piven, Frances Fox, 108 Pollard, Spencer, 10, 27, 135 portfolio balance, 93 portfolio capital flows, portfolio choice, 32 7, 66 9, 97, 140 1, Portugal, 126 Posner, Richard, 135 Post Keynesians, 10, 23, 86, 87 8, 118, 131 poverty, Prescott, Edward, 102 presidential election (1936), 46 President s Council of Economic Advisers, 6 7, 61, 64, 107, 113, 123 price flexibility, 41 2 price level, probit regression, 56 7 production function, 92, 150 public assistance, 107 8, public policy, 7 Purvis, Douglas, 37 Q see also Tobin s q of Keynes, 76 9, 82 5 of Myrdal, 79 82, 84 5 q theory of investment, 31, 35 6 rational agents, 31 2 rational expectations, 14, 16, 19, 31 2, 34, 82, 88, 117, 131, 140, 146, rationing, 56, 58 real aggregate demand, 42 real business cycles, 101 2, 146

22 196 Index real wages, 13 16, 132, 133 Reddaway, W. Brian, 17 redistribution, relative wages, 29, 132 representative agent models, 1, 39 41, 102, Ricardian equivalence, 50, 164n26 Ricardo, David, 164n26 risk, 33, 66 9, 140 risk aversion, 19 Robertson, Dennis, 40 Robinson, Joan, 11 Romer, Paul, 102 3, 133 Rubin, Robert, 123 Salant, William, 28 Samuelson, Paul A., 3, 11, 28, 45, 47, 49, 63, 131 Sargent, Thomas, 14, 38 saving function, savings, 8, 29 30, 36, 38, 48, Scarf, Herbert, 5 Schmidt, K. J. W., 80 1, 84 5 Schumpeter, Joseph, 2, 27 8, 48, 87, 113, 157n4 seigniorage, 98, 150 Sharpe, William, 33 Shiller, Robert J., 5, 19, 39, 53, 58, 59, 115, 130 1, 147, 153 shocks, 15, 21 3, 40, 42, 155 Shubik, Martin, 5 Sidrauski, Miguel, 150 Simons, Henry, 110 Sims, Christopher, 5, 60 simulating nonlinear dynamics (SND), 148 Smith, Gary, 37, 60 1, socialized medicine, 110 social policy, Social Security, 50, social welfare, Solow, Robert M., 3, 6, 11, 46 7, 90, 93 5, 104, 131, Sorenson, Theodore, 6 Spain, 126 specific egalitarianism, speculative bubbles, 89 speculative motive, 31 3, 66 square root rule, 19, 24 5, 35, 60, 65, 157n9, 164n27 Srinivasan, T. N., 5, 120 stability, 20 3, 42, 153, 154 stabilization policy, 9 11, 112 Staehle, Hans, 46 steady-state growth, 104 5, 149 Stevenson, Adlai, 6 Stigler, George, 109 Stigler, Stephen, 46 Stiglitz, Joseph, 114, 121, 123 5, 127 stochastic growth model, 102 stock-flow models, 36 Stone, Richard, 3, 51 Summers, Lawrence, 124 supply-side economics, 125 Survey Research Center, 55 6 Swan, Trevor, 93 4 Sweezy, Paul, 81 2 taxation, 98 9, tax cuts, 6, 125 Taylor, John, 29, 132 temporary assistance to needy families (TANF), 111 A Theoretical and Statistical Analysis of Consumer Saving (Tobin), 48, 49 50, 138 Thornton, Henry, 12 time-series data, 44 5, 51 2, 54 5, 58, 61 Tobin, Elizabeth, 3, 4 Tobin, James doctoral dissertation of, 48, 49 50, 63, 138 as econometrician, economic growth and, influences on, 2 3, 7 8, 10, 45 6, 48, IS-LM framework analysis of, as Keynesian, 10 23, legacy of, life and career of, 1 9 loss of influence of, Tobin estimator, 1 Tobin separation theorem, 1, 67, 140 Tobin s q, 1, 8, 11, 14, 18, 31, 35 6, 72, 73 89, 142 Tobin tax, 1, 11, 74,

23 Index 197 Tobit estimator, 1, 55 8 Tobit model, 30, 44, 45, 57 8 transaction costs, 19 transaction motive, 31 2, 34 5 transfer payments, 109 Treatise on Money (Keynes), 11, 26, 71, 76 9, 85, 89 uncertainty, 17, 140 unemployment, 12 13, 15, 21, 23, 73, 107, 112, 132 6, 146 7, 152 University of Chicago, 4, 33 utility function, 150 vector autogression (VAR), 60 wage flexibility, 21 2 wages, 12, 13, 15, 41, 132 4, 152 3, 161n9 Wallace, Neil, 14 Wall-Street Treasury complex, 123 Walras-Keynes-Phillips model, 21, 22 3 Walras s Law, 19 20, 22, 39, 40 Warburton, Clark, 17, 63 War on Poverty, 107 Washington consensus, Watson, G. S., 51 wealth, 18, 20, 29 30, 39, 50, 93 wealth constraint, 24 welfare, 107 8, Wicksell, Knut, 71, 158n1 Williams, John H., 26 Wilson, Edwin B., 2, 46 windfalls, 78 Woodford, Michael, 71, 102, 151 World Bank, 123 Wouk, Herman, 3 Wulwick, Nancy, 54 Yale School, 36 8, 64, 65, 70, 73 4, 149 Yale University, 3, 4 5, 17, 33 Yellen, Janet, 130 Yoon, Bong Joon, 54