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2011 | Buch

The Life Cyclists

Fisher, Keynes, Modigliani and Friedman

verfasst von: Colin Read

Verlag: Palgrave Macmillan UK

Buchreihe : Great Minds in Finance

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Read addresses the contributions of significant individuals to our understanding of financial decisions and markets. Great financial theorists created the basis for what we now know as personal finance and this volume describes four great minds in finance that forever established the role of the rate of return and life cycle decision-making.

Inhaltsverzeichnis

Frontmatter

Introduction

1. Introduction
Abstract
This first book in the Great Minds in Finance series begins by establishing a framework upon which all the subsequent discussions rest. We describe how individuals make financial decisions over time and why these decisions change as we age and our circumstances change. The early financial theorists, including Irving Fisher, Frank Ramsey, John Maynard Keynes, Franco Modigliani, Milton Friedman, and others, recognized that the static time-independent models of classical economics were ill-equipped to describe how households balance the present and the future. It is this expansion of traditional economic models to such intertemporal decision-making that defined the development of personal finance.
Colin Read

A World Before Fisher

2. A World Before Fisher
Abstract
Milton Friedman, the icon of laissez-faire economics, called Irving Fisher “the greatest economist the United States has ever produced.”2 To place his contributions in context, let us first outline the level of sophistication before Fisher’s insights at the cusp of the twentieth century. As we do so, we will see that a novel insight into a familiar problem is the hallmark of a great mind. We also see that great minds often take innovative concepts much further than could be contemplated by others at the time. Once we understand their enlightenment, their innovations seem obvious.
Colin Read

Irving Fisher

Frontmatter
3. The Early Years
Abstract
It is not unusual for important events in one’s youth to influence significant decisions in adulthood. At times, these same events can influence an entire career. Yet it is rare when such events influence and perhaps create an entire discipline of study. In this respect, Irving Fisher’s early life takes on greater meaning.
Colin Read
4. The Times
Abstract
Irving Fisher was a pioneer in economics. While mathematics is now a requisite skill in any advanced study of finance or economics, the use of mathematics in economics was still unusual in the late 1800s. Obviously, without mathematical techniques, now called the quantitative school, there could be no finance theory. The qualitative and descriptive approach to social sciences that prevailed at the time could not possibly answer the questions of when and how much, which are so important in finance theory and financial planning today. Fisher must be credited for firmly placing economics and finance on a seemingly irreversible and much more rigorous path.
Colin Read
5. The Theory
Abstract
No great mind had earlier placed the rate of interest in the context presented by Irving Fisher. He had taken a notion developed in 1834 — that capital accumulation and the interest rate interact to optimize human wellbeing at each moment of time — and tied together capital and interest with the concepts of mortality, wealth, foresight, family regard, and self-control. More than two decades after the publication of The Rate of Interest in 1908, Fisher revisited and rewrote the treatise in 1930. Retitled The Theory of Interest and redefining self-control as impatience, he redrew intertemporal choice in a way that has been applied in finance ever since.
Colin Read
6. Applications
Abstract
In one fell swoop, Irving Fisher unified what had been two distinct areas of research. Ever since Adam Smith, there had been significant discussion on the meaning of the interest rate as a reward to capital. Eugen von Böhm-Bawerk had realized that there was a discrepancy between the amount one was willing to invest and the flow of profits in the future from that investment. For instance, a $10,000 investment that could generate annual returns of $1,000 for ten years and have no remaining residual (or scrap) value thereafter would not be considered profitable.
Colin Read
7. Life and Legacy
Abstract
There is no doubt that Fisher clarified and elaborated upon the contribution of others in the interpretation of impatience as a motivation for present and future consumption and savings. His insights from the intertemporal theory of consumption have been invaluable, even if any precise predictions remained elusive. The overall approach to decisions over time remains today the essence of our understanding of financial markets. In addition, the implications of the Fisher equation remain one of the most frequently discussed, and perhaps misunderstood, of all financial relationships.
Colin Read

John Maynard Keynes

Frontmatter
8. The Early Years
Abstract
To understand John Maynard Keynes is to grasp the most conventional environment of which he was a product — at least the environment that bred the elite of Victorian England. While the Victorian period ended with Queen Victoria’s death in 1901, just as Keynes entered his senior year at Eton, the world’s most elite preparatory school, he was enjoying his formative years as the British Empire was reaching its apex of global reach and power.
Colin Read
9. The Times
Abstract
Irving Fisher had provided the world with the first formal and elegant model to motivate personal finance. But while his analysis refined and expanded the state of the art of mathematical methods in finance theory until the middle of the early twentieth century, he was unable to tease from the analysis what must be left for more elaborate techniques.
Colin Read
10. The Theory
Abstract
By the Great Depression, Fisher’s theory of savings and investment had prevailed for a generation. He saw savings and investments as two sides of the same equation. One represented savings and consumption deferred today to provide for more consumption tomorrow. The other was savings directed toward the creation of future capacity to produce and thus to fuel tomorrow’s consumption. Technically, inventories also represented investment. However, this balance between inventory and capacity was, in Fisher’s words, “managed by captains of industry” who understood the workings of the modern economy better than anyone who had come before them.81
Colin Read
11. Applications
Abstract
In a dramatic departure, John Maynard Keynes’ approach used little mathematics, no calculus or statistics, and little of the language that had been embraced by the economics discipline by the 1930s and 1940s. Rather, Keynes used intuition to describe those phenomena that the classical model had not covered.
Colin Read
12. Life and Legacy
Abstract
John Maynard Keynes’ legacy stems primarily from his theory of optimal economic policy during recessions and stagnations. However, forgotten in the invocation of Keynesian policies to expand macroeconomic output and income, and to reduce unemployment, is that Keynes stood squarely in the middle of the debate over the meaning and significance of interest rates. Like Irving Fisher, the father of a classical interpretation of the role of the interest rate, Keynes also tied consumption, future consumption, and savings to the interest rate. In doing so, he was equally significant in our interpretation of the interest rate and its effect on consumption and savings. While Fisher is often regarded as a pioneer in the study of finance, Keynes is rarely remembered for his contribution to our understanding of interest rates and personal finance. Rather, we must remember that Keynes’ most influential treatise, The General Theory of Employment, Interest and Money, expressly described the role of, and a new interpretation for, the interest rate and devoted one of the three main sections to the interest rate and investment.
Colin Read

Franco Modigliani

Frontmatter
13. The Early Years
Abstract
In 1918 Irving Fisher was on his way to making his first million dollars and was contemplating the suitability of the term “utility,” coined by Professor William Stanley Jevons.101 Students of economics and finance still ponder this term today. Keynes was working on his first major and popular book, The Economic Consequences of the Peace. Fisher was 51 years old and Keynes had just turned 35. Meanwhile, in Rome, Italy, on June 18, 1918, Franco Modigliani was born.
Colin Read
14. The Times
Abstract
John Maynard Keynes had provided those who study personal finance with a new understanding of the role of savings. His model determined that the savings rate should depend on a household’s level of income. Irving Fisher had earlier developed a model under the not unreasonable assumption of what are known technically to be homothetic indifference curves, for which the savings rate remains constant as income rises. Keynes departed from this assumption and instead offered motivation for a vast array of instruments that acted as imperfect substitutes for each other in our financial decisions. Savings were a substitute for current consumption. However, savings were not merely deferred consumption; they represented aspects that were precautionary and speculative and could be realized in many ways, some of which flow into traditional investment markets that increase future productivity, but others of which do not.
Colin Read
15. The Theory
Abstract
In the early post-war period, there remained little understanding of the personal financial decisions of households. Various researchers had noticed discrepancies in the data that more simplistic models from Irving Fisher and John Maynard Keynes could not explain. The data suggested that consumption remained remarkably stable over time, which implied that savings, as the difference between disposable income and consumption, would be highly volatile as income changed. Savings, too, seemed to follow a steadier path.
Colin Read
16. Applications
Abstract
While the fresh but simple approach by Franco Modigliani and Richard Brumberg produced some starkly insightful and profound new results, we can now include their insights while at the same time unifying the results of Irving Fisher and Frank Ramsey by utilizing the recent technique of optimal control theory.
Colin Read
17. The Nobel Prize, Life, and Legacy
Abstract
Each in their own way, Irving Fisher, John Maynard Keynes and then Franco Modigliani made profound contributions to the field of personal finance. Fisher described the process by which those with a high individual rate of time preference would borrow at a lower prevailing interest rate and would represent the demand for loanable funds. On the other hand, those willing to save because the interest rate offered in market equilibrium was larger than their rate of time preference provided the supply of funds to lending markets.
Colin Read

Milton Friedman

Frontmatter
18. The Early Years
Abstract
Like those founders of personal finance before him, Milton Friedman lived an interesting life punctuated by events that would form his thinking. Like Franco Modigliani, Friedman was from a Jewish heritage. However, unlike Modigliani, who had to flee to the USA to escape the oppression of fascism, Friedman was born into a family that was already firmly, if just barely, rooted on US soil.
Colin Read
19. The Times
Abstract
In the midst of the Great Depression, during which Irving Fisher had been disgraced for his faith in simplistic classical remedies to an almost perpetually painful economic problem, and John Maynard Keynes was penning his The General Theory of Employment, Interest and Money in frustration with the classical model, Milton Friedman was cultivating his Chicago-influenced views and Franco Modigliani was about to enter college. There were emerging three schools of thought, which Friedman eloquently summarized years later in his memoirs, in recollection of a public debate between himself and the economist Abba Lerner of the London School of Economics:
I was myself first strongly impressed with the importance of the Chicago tradition during a debate on Keynes between Abba P. Lerner and myself before a student-faculty seminar at the University of Chicago sometime in the late 1940s (or perhaps the early 1950s). Lerner and I were graduate students during the early 1930s, pre-Keynes’s General Theory; we have a somewhat similar Talmudic cast of mind and a similar willingness to follow our analysis to its logical conclusion. Those have led us to agree on a large number of issues — from flexible exchange rates to the volunteer army. Yet we were affected very differently by the Keynesian revolution — Lerner becoming an enthusiastic convert and one of the most effective expositors and interpreters of Keynes, I remaining largely unaffected and if anything somewhat hostile.
Colin Read
20. The Theory
Abstract
Milton Friedman’s permanent income hypothesis was controversial from the onset. It was not that the theory was an unreasonable or empirically untestable one; rather, it was the offshoot of a strand of research that Simon Kuznets and Friedman had pursued in the mid-1940s.
Colin Read
21. Applications
Abstract
Milton Friedman’s results were significant, even if they differed substantially from those of Franco Modigliani. Both Modigliani and Friedman were motivated by the need to explain empirical observations in the rate of savings of households. Both correctly surmised that savings could not be determined without modeling consumption — as it is consumption, now or in the future, that Irving Fisher demonstrated to us would determine the saving decision.
Colin Read
22. The Nobel Prize, Life, and Legacy
Abstract
Apart from his theories, Milton Friedman set the tone by which his profession would be judged. Economics branched from esoteric discussions of class and the human condition and into the realms of money, finance, savings, and high finance.
Colin Read

What We Have Learned

Frontmatter
23. Combined Contributions
Abstract
These great minds motivated our knowledge of what we now call personal finance. As a consequence of their contributions, we now think of financial markets not only as a tool to mobilize capital for industry but also as the vehicle that evens out our consumption over our lifetime, prepares us so that we may retire in comfort from our working life, and insures us against the vagaries of the business cycle.
Colin Read
24. Conclusions
Abstract
One cannot help but be struck with the larger-than-life personas of four very different individuals who would found and define the field of personal finance. From self-made descendants of pioneer stock to British blueblood, and a pair of brilliant theoreticians with Jewish immigrant heritage, each embraced their upbringings to enlighten their insights into the cornerstones of personal finance.
Colin Read
Backmatter
Metadaten
Titel
The Life Cyclists
verfasst von
Colin Read
Copyright-Jahr
2011
Verlag
Palgrave Macmillan UK
Electronic ISBN
978-0-230-34944-5
Print ISBN
978-1-349-32429-3
DOI
https://doi.org/10.1057/9780230349445