Lives of the Laureates, Seven Nobel
Edited by William Breit and Roger W. Spencer
The MIT Press, Cambridge, Massachusetts, London, England, 1986
Beginning with Keynes at Harvard
Rare is the child, I suspect, who wants to grow up to be an economist, or a professor.
I grew up in a university town and went to a university-run high school, where most of my
friends were faculty kids. I was so unfailing an A student that it was boring even to me.
But I dont recall thinking of an academic career. I liked journalism, my
fathers occupation; I had put out "newspapers" of my own from age six. I
thought of law; I loved to argue, and beginning in my teens I was fascinated by politics.
I guess I knew that there was economics at the university, but I didn't know what the
subject really was. Of course, economic issues were always coming up in classes on history
and government civics, in those days. I expected economics to be among die social
science courses I would someday take in college, probably part of the pre-law curriculum.
I grew up happily assuming I would go to college in my hometown, to the University of
Illinois. One month before I was scheduled to enroll as a freshman, I was offered and
accepted a Conant Prize Fellowship at Harvard. I should explain how this happened. My
father, a learned man, a voracious reader, the biggest customer of the Champaign Public
Library, discovered in the New York Times that Harvard was offering two of these
new fellowships in each of five midwestern states. President Conant wanted to broaden the
geographical and social base of Harvard College. Having nothing to lose, I accepted my
fathers suggestion that I apply. University High School, it turned out, had without
even trying prepared me superbly for the obligatory College Board exams. Uni High
graduates only thirty to thirty-five persons a year, but it has three Nobels to its credit
and, once I had broken the ice, many national scholarships.
Thus James Bryant Conant, Louis Michael Tobin, and University High School changed my
life and career. Illinois was and is a great university. But I doubt that it would have
led me into economics. For several reasons, Harvard did.
Harvard was the leading academic center of economics in North America at the time; only
Columbia and Chicago were close competitors. Both its senior and junior faculty were
outstanding. Two of the previous lecturers in this series were active and influential
members of the community when I was a student, Wassily Leontief on the faculty and Paul
Samuelson as a junior Fellow, a graduate student free of formal academic requirements. Of
the senior faculty of the 1930s, Joseph Schumpeter would have been a sure bet for a Nobel,
Alvin Hansen, Edward Chamberlin, and Gottfried Haberler likely choices. Haberler, still
active, remains a possibility. Naturally, Harvard attracted remarkably talented graduate
students. That able undergraduates might go on to scholarly careers was taken for granted.
When I arrived at Harvard, I knew I would want to major at Harvard the word is concentrate
in one of the social sciences or possibly in mathematics. By the end of freshman
year I was leaning to economics. But I hadnt yet taken any. In those days even Ec A,
the introductory course, was considered too hard for freshmen. As a sophomore all of
eighteen years old, I began Ec A in a section taught by Spencer Pollard, an advanced
graduate student specializing in labor economics and writing a dissertation on John L.
Lewis and the United Mine Workers.
Pollard was also my tutor. A Harvard undergraduate, besides taking four courses, met
regularly, usually singly, with a tutor in his field of concentration, generally a faculty
member or graduate student associated with the students residential house. Tutorial
was not graded. It was modeled, like the house system itself, on Oxford and Cambridge.
Pollard suggested that we devote our sessions to "this new book from England."
He had recently been over there and judged from the stir the book was creating even before
publication that it was important. The book was The General Theory of Employment,
Interest and Money by John Maynard Keynes, published in 1936.
Pollard was no respecter of academic conventions; that I was only an Ec A student meant
nothing to him. I was too young, and too ready to assume that teacher knows best, to know
that I knew too little to read the book. So I read it, and Pollard and I talked about it
as we went through it. Cutting my teeth on The General Theory, I was hooked on
Like many other economists of my vintage, I was attracted to the field for two reasons.
One was that economic theory is a fascinating intellectual challenge, on the order of
mathematics or chess. I liked analytics and logical argument. I thought algebra was the
most eye-opening school experience between the three Rs and college.
The other reason was the obvious relevance of economics to understanding and perhaps
overcoming the great depression and all the frightening political developments associated
with it throughout the world. I did not personally suffer deprivations during the
depression. But my parents made me very conscious of the political and economic problems
of the times. My father was a well-informed and thoughtful political liberal. My mother
was a social worker, recalled to her career by the emergency; she was dealing with cases
of unemployment and poverty every day.
The second motivation, I observe, gave our generation of economists different interests
arid priorities from subsequent cohorts dominated by those attracted to the subject more
exclusively by the appeal of its puzzles to their quantitative aptitudes and interests.
Thanks to Keynes, economics offered me the best of both worlds. I was fascinated by his
theoretical duel with the orthodox classical economists. Keyness uprising against
encrusted error was an appealing crusade for youth. The truth would make us free, and
fully employed too. I was already an ardent and uncritical New Dealer, much concerned
about the depression, unemployment, and poverty. According to Keynesian theory,
Roosevelts devaluation of the dollar and deficit spending were sound economics after
By sheer application, unconstrained by the need to unlearn anything, I came to know
Keyness new book sooner and better than many of my elders at Harvard. Keynes was the
founder of what later came to be known as macroeconomics, what his young associate Joan
Robinson called at the time "the theory of output as a whole," a phrase I found
strikingly apt. The contrast was with the theory of output and price in particular markets
or sectors. This what we now call "micro" was the main stuff of
the theory course we economics concentrators took after Ec A. I liked the methodology of
the new subject, modeling the whole economy by a system of simultaneous equations; by now
I had calculus to add to my algebra. J.R. Hicks and others showed, more clearly than
Keynes himself, how the essentials of The General Theory, and its differences from
classical theory, could be expressed and analyzed in such models.
Harvard was becoming the beachhead for the Keynesian invasion of the new world. The
senior faculty was mostly hostile. A group of them had not long before published a book
quite critical of Roosevelts recovery program. Seymour Harris, an early convert to
Keynes, was an exception, especially important to undergraduates like myself, in whom he
took a paternal interest. Harris was an academic entrepreneur. He opened the pages of the
Review of Economics and Statistics, of which he was editor, and the halls of Dunster
House, of which he was senior tutor, to lively debates on economic theory and policy.
The younger faculty and the graduate student teaching fellows were enthusiastic about
Keynes's book. Their reasons were similar to my own but better informed. A popular tract
by seven of them, An Economic Program for American Democracy, preached the new
gospel with a left-wing slant.
Most important of all was the arrival of Alvin Hansen to fill the new Littauer chair in
political economy. Hansen, aged fifty, came to Harvard from the University of Minnesota
the same year I was beginning economics. He had previously been critical of Keynes and had
indeed published a lukewarm review of The General Theory. He changed his mind 180
degrees, a rare event for scholars of any age, especially if their previous views are in
print. Hansen became the leading apostle of Keynesian theory and policy in America. His
fiscal policy seminar was the focus of research, theoretical and applied, in Keynesian
economics. Visitors from the Washington firing lines mixed with local students and
faculty; I had the feeling that history was being made in that room. For undergraduates
the immediate payoff was that Hansen taught us macroeconomics, though under the course
rubric Money and Banking. Hansen was a true hero to me, and in later years he was to be a
real friend also.
I wrote my senior honors thesis on what I perceived to be the central theoretical issue
between Keynes and the classical economists he was attacking. The orthodox position was
that prices move to clear markets, rising to eliminate excesses of demand over supply and
falling to eliminate excess supplies. Applied to the labor market, this meant that
reductions of wages would get rid of unemployment. Excess supply of labor could not be a
permanent equilibrium. Unless wage cuts are prevented by law or by monopolistic trade
unions, competition for jobs will lower wages and in turn restore or create jobs for the
unemployed. This was just an application of the central thesis of orthodox economics, the
Invisible Hand proposition of Adam Smith. Individual agents are selfish and myopic. They
respond in their own interest to the market signals locally available to them. Their
actions miraculously turn out for the best for the society as a whole. Competition brings
this miracle about.
Keyness heresy was to deny that this mechanism could be counted on to eliminate
involuntary unemployment. He didnt say just that the mechanism was slow and needed
help from government policy. He said it might not work at all. Instead, the economy would
be stuck in an underemployment equilibrium. Orthodox economists thought they could prove
that free competitive markets allocate resources efficiently. In saying that willing and
productive workers cant get jobs, Keynes was indicting the market system for a
massive failure. After all, there is no greater inefficiency than to leave productive
My honors thesis found fault with Keyness logic. That may seem surprising. But I
didnt think Keynes needed to insist on so sweeping a theoretical victory on his
opponents home court. His practical message was just as important whether
unemployment was an incident of prolonged disequilibrium or of equilibrium. My first
professional publication (1941) was an article in the Quarterly Journal of Economics
based on my senior thesis; the QJE is, of course, edited and published at Harvard.
The issue is very much alive today. It has also remained an interest of mine, a subject on
which I have published several other papers, including my 1971 presidential address to the
American Economic Association (1972).
Tools of the Trade, Theoretical and Statistical
By graduation time in 1939 I had forgotten about law and drifted into the natural
decision, to become a professional economist. Harvard has a way of keeping its own: my
fellowship was extended and I went on to graduate school. The transition was easy; I had
taken courses with graduate students while I was a senior. Now I needed to pick up some
tools of the trade. One was formal mathematical economic theory, and another was
statistics and econometrics. Harvard was just beginning to catch up to the state of these
I see in retrospect that our professors left most of our education to us. They expected
us to teach ourselves and learn from each other, and we did. They treated us as adult
partners in scholarly endeavor, not as apprentices. I am afraid our graduate programs
today try too hard to convey a definite and vast body of material and to test how well
students master what we know. I wrote my undergraduate thesis under the nominal
supervision of my senior-year tutor, Professor Edward Chamberlin. He said he knew nothing
about my subject and left me on my own. Our tutorial sessions were nonetheless
interesting; we argued about Catholic agrarianism, his vision of economic utopia. The
faculty adviser for my doctoral dissertation in 194647 was, by my choice, Professor
Schumpeter, one of the truly great economists, indeed social scientists, of the century.
He had no use for Keynes and little for my topic, the consumption function. He read what I
wrote and made helpful suggestions, but mostly he kept hands off. When I saw him, we
talked of many other things, to my lasting benefit.
The theory we were taught was largely in the Anglo-American tradition, in which
mathematical argument was subordinated to verbal and graphical exposition and relegated to
footnotes. The great book was Principles of Economics by Alfred Marshall,
Keyness own mentor in the other Cambridge. Markets were analyzed mostly one at a
time partial equilibrium analysis. Little rigorous attempt was made to
describe a general equilibrium of the system as a whole, with many commodities,
many consumers and producers, many markets interconnected with each other.
Mathematical models of general equilibrium were a stronger tradition in continental
Europe, to which the French-Swiss economist Leon Walras had made the seminal contribution
in 1870. Though F.Y. Edgeworth at Oxford and Irving Fisher at Yale had written in the same
vein, they had not greatly influenced the main line of English-language economics from
Adam Smith to David Ricardo to John Stuart Mill to Marshall. But in the late 1930s and
1940s the mathematical general equilibrium approach was coming into vogue, thanks to J.R.
Hicks and R.G.D. Allen in Britain and Wassily Leontief and Paul Samuelson at Harvard.
Joseph Schumpeter fostered this development, believing that Walras had provided economics
its "magna charta," even though his own theory of the dynamics of capitalism was
I liked the general equilibrium approach; that was one of the great appeals of
macroeconomics. But those models of output as a whole were small enough and specific
enough to understand and manipulate. I have never been an aficionado of formal
mathematical general equilibrium theory, which is so pure and general as to be virtually
devoid of interesting operational conclusions. Moreover, I have come to think that its
elegance gives many economic theorists today an exaggerated presumptive faith that free
competitive markets work for the best. I did use the approach in some articles in the late
1940s on the theory of rationing, all but one of them in collaboration with Hendrik
In statistics and econometrics Harvard was further behind the times. The professors who
taught economic statistics were idiosyncratic in the methods they used and quite
suspicious of methods based in mathematical statistical theory. Until the 1950s Harvard
was pretty much untouched by the developments in Europe led by Ragnar Frisch and Jan
Tinbergen or those in the United States at the Cowles Commission. Students like me, who
were interested in formal statistical theory, took refuge in the mathematics department.
For econometrics we squeezed as much as possible from a seminar on statistical demand
functions offered by a European visitor, Hans Staehle. We also discovered that
regressions, though scorned by professors Crum and Frickey, were alive and well under the
aegis of Professor John D. Blacks program in agricultural economics. In the basement
of Littauer Center we could use his electromechanical or manual Marchands and Monroes.
I did just that for my second published paper (1942), originally written for Edward S.
Masons seminar in spring semester 1941, on how to use statistical forecasts in
defense planning; my example was estimation of civilian demands for steel. The paper was
one reason Mason recommended me for a job in Washington with the civilian supply division
of the nascent Office of Price Administration and Civilian Supply. So I left Harvard in
May 1941, having completed all the requirements for the Ph.D. except the dissertation. I
would not return until February 1946. After nine months of helping to ration scarce
materials, I went in the Navy and served as a line officer on a destroyer until Christmas
Statistics and econometrics were important in my research after the war. in my doctoral
dissertation (1947) on the determinants of household consumption and saving, I tried to
marry "cross-section" data from family budget surveys with aggregate time
series, the better to estimate effects of income, wealth, and other variables. In a later
study of food demand (1950), I refined the method. This, along with my empirical and
theoretical work on rationing, took place in England in 194950, at Richard
Stones Department of Applied Economics in Cambridge. I hoped that cross-section
observations could resolve the ambiguities of statistical inference based on time series
alone. Later my interest in cross-section and panel data led me to the work of the
Michigan Survey Research Center, where I spent a fruitful semester with George Katona,
James Morgan, and Lawrence Klein in 1953.
My work on data of this type led me to propose a new statistical method, which became
known as Tobit analysis (1958). Probit analysis, which originated in biology, estimates
how the probabilities of positive or negative responses to treatment depend on observed
characteristics of the organism and the treatment. In economic applications, Yes responses
often vary in intensity; for example, most families in a sample would report No when asked
if they bought a car last year, while those who answer Yes spent varying amounts of money
on a car. My technique would use both Yes-No and quantitative information in seeking the
determinants of car purchases.
The label Tobit was perhaps more appropriate than Arthur Goldberger thought when he
introduced it in his textbook. Perhaps not. My main claim to fame, a discovery enjoyed by
generations of my students, is that, thinly disguised as a midshipman named Tobit, I make
a fleeting appearance in Herman Wouks novel The Caine Mutiny. Wouk and I
attended the same quick Naval Reserve officers training school at Columbia in spring
1942, and so did Willy, the hero of the novel.
Innovative and seminal work in mathematical economics and econometrics took place at
the Cowles Commission for Research in Economics in the years 19441954. The
commission was then affiliated with the University of Chicago. Its research output over
that period is one of the most fruitful achievements in the history of organized
scientific inquiry. The leaders were Jacob Marschak and Tjalling Koopmans; Koopmans was
awarded a Nobel Prize for his contributions to the theory of resource allocation,
including linear programming, during this period. The remarkable teams Marschak and
Koopmans assembled included two of the previous speakers in this series at Trinity, Arrow
and Klein, and two other Nobel laureates, Simon and Debreu.
When I was a graduate student at Harvard after the war, I stood in awe of the Cowles
Commission and of Marschak and Koopmans. I came to know them at meetings of the
Econometric Society. For the December 1947 meeting in Chicago I was asked to be a
discussant of a paper by Marschak. I didnt get the paper until a few days before the
meeting, indeed a day or so before Christmas. I worked hard on the paper neglecting
my wife, Betty, pregnant with our first child, and holiday festivities with our families.
I was able to report some important flaws in Marschaks model and to offer some
constructive suggestions. One thing led to another. I was asked to join the commission,
and in 1954 1 was asked to become its research director, to succeed Koopmans as he had
The offer was flattering, challenging, and tempting. But I was very happy at Yale, and
Betty and I had come to like New Haven very much as a place to live and raise a family. It
turned out that we could have our cake and eat it too. Koopmans was quite interested in
relocating the commission, because of difficulties in attracting staff to Chicago at that
time and problems in the relation between the commission and the university. He gave rue
not the slightest inkling of this interest until I had definitely declined the offer. The
founder and financial angel of the commission, Alfred Cowles, was a Yale graduate; he
hoped his creation could find permanent hospitality from his alma mater.
In 1955 the commission moved to Yale, renamed the Cowles Foundation for Research in
Economics at Yale University. I became its research director after all. Cowles Foundation
Discussion Paper 1 (1955) was a precursor of the Tobit analysis mentioned above. The
coming of Cowles was an important factor in the rise of economics at Yale to front-rank
stature. I broadened the scope of the foundations research to include
macroeconomics. I was particularly eager to make room for the interests and talents of a
young Yale assistant professor, Arthur Okun, who was working on macroeconomic forecasting
and policy analysis.
Developing Keynesian Macroeconomics; Synthesizing it with the Neoclassical
My main program of research and writing after the war continued my early interests in
Keynes and macroeconomics. I sought to improve the theoretical foundations of macro
models, to fit them into the main corpus of neoclassical economics, and to clarify the
roles of monetary and fiscal policies. In this endeavor I shared the objectives of many
other economists, notably Abba Lerner, Paul Samuelson, Franco Modigliani, Robert Solow,
J.R. Hicks, and James Meade. A new mainstream, synthesizing the Keynesian revolution and
the classical economics against which it was revolting, was in the making. I am proud that
Paul Samuelson called me a "partner in [this] crime."
The building blocks of the Keynesian structure were four in number: the relation of
wages and employment; the propensity to consume; liquidity preference and the demand for
money; the inducement to invest. I have already referred to my work on the first. I turn
now to the other three.
Keyness "psychological law" of consumption and saving stated that
saving would be an ever-larger proportion of income as per capita real incomes became
greater. National income data between the two world wars appeared to confirm his law.
Statistical equations, fit to those data, extrapolated to much higher incomes, foretold
trouble after the Second World War. Investment would have to be a much larger fraction of
national income than ever before to absorb the high saving and avoid recession and
unemployment. The extrapolation was wrong. Incomes rose as expected, but consumption was
no smaller a proportion than before. This forecasting error triggered an agonizing
reappraisal of the consumption function, with fruitful results.
My doctoral dissertation (1947) was on this subject. I thought Keyness law should
be interpreted to refer to the relation of lifetime consumption to lifetime income, not to
a relation between those variables year by year. The same considerations implied that
wealth, not just current income, determines consumption in the short run. As so often
happens, this idea was in the air. Milton Friedmans permanent income theory and
Franco Modiglianis life-cycle model were elegant explanations of saving behavior in
this spirit. They showed how cyclical data could look "Keynesian" even though
saving would be roughly proportional to income in the long run. I have written a number of
papers on this subject over the years.
The episode is, I believe, an example of how economic knowledge advances when striking
real-world events and issues pose puzzles we have to try to understand and resolve. The
most important decisions a scholar makes are what problems to work on. Choosing them just
by looking for gaps in the literature is often not very productive and at worst divorces
the literature itself from problems that provide more important and productive lines of
inquiry. The best economists have taken their subjects from the world around them.
The bulk of my work in the 1950s and 1960s was on the monetary side of macroeconomics.
I had several objectives.
First, I wanted to establish a firm foundation for the sensitivity of money demand or
money velocity to interest rates. Why was this important? The quantity theory of money,
later called monetarism, asserted that there was no such sensitivity, that the velocity of
money was constant except for random shocks and for slow, secular changes in public
habits, banking institutions, and financial technology. The implication was that fiscal
stimulus, such as government spending or tax reduction, could not affect aggregate
spending on goods and services unless accompanied by money creation. The same implication
applied to autonomous changes in private investment. In this sense Milton Friedman and
other monetarists were saying not just that money matters, with which I agreed, but also
that money is all that matters, with which I disagreed.
In an empirical paper in 1947 I let the data speak for themselves, loudly in favor of
Keyness liquidity preference curve. But I was not satisfied with Keyness
explanation of liquidity preference. He said people preferred liquid cash because they
expected interest rates to rise to "normal" prosperity levels of the past,
causing capital losses on holdings of bonds. As William Fellner, later to be my colleague
at Yale, pointed out in a friendly debate with me in journal pages, Keynes could hardly
call "equilibrium" a situation in which interest rates are persistently lower
than investors expectations of them. Fellner was espousing a principle of model
building later called "rational expectations," and I agreed with him.
I found and offered two more tenable sources of the interest sensitivity of demand for
money. One (1956) was based on an inventory theory of the management of transactions
balances. As I learned too late, I had been mostly anticipated by William Baumol, but the
model is commonly cited with both names. The second paper (1958) gave a new
rationalization of Keyness "speculative motive": simply, aversion to risk.
People may prefer liquidity, and prefer it more the lower the interest rate on noncash
assets, not because they expect capital losses on average but because they fear them more
than they value the equally probable capital gains.
I had been working for some time on portfolio choices balancing such risks against
expected returns, and the liquidity preference paper was an exposition and application of
that work. Harry Markowitz had already set forth a similar model of portfolio choice, and
our paths also converged geographically when he spent a year at Yale in 195556. My
interest was in macroeconomic implications, his more in advising rational investors.
When my prize was announced in Stockholm in 1981, the first reports that reached this
country mentioned portfolio theory. This caught the interest of the reporters who faced me
at a hastily arranged press conference at Yale. They wanted to know what it was, so I did
my best to explain it in lay language, after which they said "Oh no, please explain
it in lay language." Thats when I referred to the benefits of diversification:
"You know, dont put all your eggs in one basket." And that is why
headlines throughout the world said "Yale economist wins Nobel for Dont
put all your eggs...," and why a friend of mine sent me a cartoon he had
clipped, which followed that headline with a sketch of next years winner in medicine
explaining how his award was for "An apple a day keeps the doctor away.
The fact that one of the available assets in the model of my paper was riskless turned
out to have interesting consequences. I felt somewhat uneasy and apologetic that I was
pairing the safe asset with just one risky asset to represent everything else. This
aggregation followed Keynes, who also used "the interest rate" to refer
to the common yield on all nonmoney assets and debts. I proved that my results would apply
even if any number of risky assets were available, each with different return and risk.
The choice of a risky portfolio, the relative weights of the various risky assets within
it, would be independent of the decision how much to put into risky assets relative to the
safe asset, money. This "separation theorem" was the key to the capital asset
pricing model developed by Lintner and Sharpe, beloved by finance teachers and students,
and exploited by the investment managers and counselors who compute and report the
"betas" of various securities.
The debate about fiscal and monetary policy, as related to the interest-sensitivity of
demand for money, went on for a long time, too much of it a duel between Milton Friedman
and me. In a Vermont ski line a young attendant checking season passes read mine and said
in a French-Canadian accent, "Tobeen, James Tobeen, not ze economiste! Not ze enemy
of Professeur Friedman!" He was an economics student in Quebec; it made his day. He
let me pass to the lift. This debate, I would say, ended for practical purposes when
Friedman shifted ground, saying that no important issue of monetary policy or theory
depended on interest-sensitivity of money demand. The ground he shifted to was the basic
issue between Keynes and the classics, the contention that the economy is always in a
supply-constrained equilibrium where neither monetary nor fiscal policy can enhance real
Second, I proposed to put money into the theory of long-run growth. In the 1950s one
phase of the synthesis of Keynesian and neoclassical economics was the development of a
growth theory along neoclassical lines. Some, not all, Keynesians were ready to agree that
in the long run employment is full, saving limits investment, and "supply creates its
own demand." The short run was the Keynesian domain, where labor and capital may be
underemployed, investment governs saving, and demand induces its own supply. Roy Harrod
had started modern growth theory in 1939, followed by Evsey Domar in the 1940s and Trevor
Swan, Robert Solow, Edmund Phelps, and many others in the 1950s and 1960s.
I was involved too. My 1955 piece, "A Dynamic Aggregative Model," may be my
favorite; it was the most fun to write. It differed from the other growth literature by
explicitly introducing monetary government debt as a store of value, a vehicle of saving
alternative to real capital, and by generating a business cycle that interrupted the
growth process. In three subsequent papers (1965, 1968, and 1985) I showed that the stock
of capital in a growing economy is positively related to the rates of monetary growth and
Third, in a long series of papers I developed, together with William Brainard and other
colleagues at Yale, a general model of asset markets and integrated it into a full
macroeconomic model. In a sense we generalized Hickss famous IS/LM formalization of
Keynes by allowing for a richer menu of assets. As I already indicated, I had been
uncomfortable with that unique "the interest rate" in Keynes and with the
simple dichotomy of money versus everything else, usually described as money versus bonds.
I thought nominal assets versus real capital was at least as important a way of splitting
wealth, if it must be split in only two parts, and this is what I did in the growth models
Portfolio theory suggested that assets should be regarded as imperfect substitutes for
each other, with their differences in expected yields reflecting their marginal risks. Our
approach also suggested that there is no sharp dividing line between assets that are money
and those that are not. The "Yale approach" to monetary and financial theory has
been widely used in empirical flow-of-funds studies and in modeling international capital
Our approach also explicitly recognizes the stock-flow dynamics of saving, investment,
and asset accumulation, as in my 198 1 Nobel lecture. These dynamics were explicitly
ignored in Keynes, who defined the short run as a period in which the change in the stock
of capital due to the flow of new investment is insignificant. Stock-flow dynamics are
also ignored in IS/LM models. But flows do add to stocks. Investment builds the capital
stock, government deficits enlarge the stocks of government bonds and possibly of money,
trade surpluses increase the net assets of the nation vis-à-vis the rest of the world,
and so on. Without these effects, macro stories about policies and other events are
The bottom line of monetary policy is its effect on capital investment, in business
plant and equipment, residences, inventories, and consumer durable goods. The effect is
not well represented by the market interest rates usually cited, or by quantities of money
or credit. Our approach to monetary economics and macroeconomics led us naturally to a
different measure, closer to investment decisions. This has become known as
"Tobins q." It is the ratio of the market valuations of capital
assets to their replacement costs, for example, the prices of existing houses relative to
the costs of building comparable new ones. For corporate businesses, the market valuations
are made in the securities markets. It is common sense that the incentive to make new
capital investments is high when the securities giving tide to their future earnings can
be sold for more than the investments cost, i.e., when q exceeds one. We see the
reverse in takeovers of companies whose qs are less than one; it is cheaper to buy
their productive assets by acquiring their shares than to construct comparable facilities
from scratch. That is why in our models q is the link from the central bank and the
financial markets to the real economy.
Policy and Public Service
As must be clear from my narrative, I have always been intensely interested in economic
policy. Much of my theoretical and empirical research has been devoted to analyzing and
discerning the effects of monetary and fiscal policies. In the 1 950s I began writing
occasional articles on current economic issues for general readership, some of them in The
New Republic, The Yale Review, Challenge, the New York Times.
Some of my friends in Massachusetts were advising Senator Kennedy. They told him and
his staff about me. In summer 1960 Ted Sorenson came to see me and arranged for the
Kennedy campaign to employ me to write some memoranda and position papers on economic
growth. Sorenson signed me up despite the fact that I had felt it necessary to tell him I
favored Stevenson for the nomination. I didnt notice any effects of my memos during
the campaign, but I was told that they were used by the Kennedy team at the party platform
deliberations, mainly to oppose the exaggerated "spend to grow" views of Leon
Keyserling and some union economists.
My message at the time was that we needed a tight budget, one that would yield a
surplus at full employment, and a very easy monetary policy, one that would get interest
rates low enough to channel the governments surplus into productive capital
investment. The point was to have frill employment, but by a mix of policies that promoted
growth in the economys capacity to produce. Incidentally, my message is similar
After the 1960 election I served on a transition task force on the domestic economy
chaired by Paul Samuelson. One day in early January 1961 I was summoned from lunch at the
faculty club to take a phone call from the president-elect. He asked me to serve as a
member of his Council of Economic Advisers. JT: "Im afraid youve got the
wrong guy, Mr. President. Im an ivory-tower economist." JFK: "Thats
the best kind. Ill be an ivory-tower president." JT: "Thats the best
kind." I took a day or two to talk to Betty and to my colleagues and then said Yes. I
served for twenty months.
Walter Heller was the chairman of the council, and Kermit Gordon was the other member.
We had a fantastic staff, including Art Okun, Bob Solow, Ken Arrow, and a younger
generation whose names would also be recognized as leaders in our profession today. We
were all congenial, intellectually and personally, and we functioned by consensus without
hierarchy or bureaucracy. We were optimistic, confident that our economics could improve
policy and do good in the world. It was the opportunity that had motivated me to embrace
economics a quarter century before.
The January 1962 Economic Report is the manifesto of our economics, applied to
the United States and world economic conditions of the day. The press called it "the
new economics," but it was essentially the blend of Keynesian and neoclassical
economics we had been developing and elaborating for the previous ten years. The report
was a collective effort, written mainly by Heller, Gordon, Solow, Okun, and Tobin. It
doesnt appear on my personal bibliography, but I am proud of it as a work of
professional economics as well as a public document. The January 1982 Report is the
comparable document of Reaganomics, likewise the effort of professional economists to
articulate a radically new approach to federal economic policy. It is interesting to
compare the two; we have nothing to fear.
The Kennedy council was effective and influential because the president and his
immediate White House staff took academics seriously, took ideas seriously, took us
seriously. JFK was innocent of economics on inauguration day. But he was an interested,
curious, keen, and able student. He read what we wrote, listened to what we said, and
learned a lot.
Our central macroeconomic objective was to lower unemployment, 7 percent inJanuary
1961, to 4 percent, our tentative estimate of the inflation-safe unemployment rate. That
goal was achieved by the end of 1965, with negligible increase in the rate of inflation
and with a big increase in capital investment The sweet success turned sour in the late
1960s, when contrary to the advice of his council and other Keynesian advisers President
Johnson failed to raise taxes to pay for the escalating costs of the war in Vietnam.
Critics looking back on the 1960s accuse the Kennedy-Johnson economists of naïve belief
in a Phillips trade-off and of policies explicitly designed to purchase lower unemployment
with higher inflation. The criticism is not justified. The council did not propose to push
unemployment below what came to be known as the "natural rate." Moreover,
beginning in 1961 the council and the administration adopted wage and price policies
designed to achieve an inflation-free recovery "guideposts for noninflationary
price and wage behavior" were espoused in the report.
I returned to Yale in September 1962. I loved the job at the council, but I knew my
principal vocation was university teaching and research. Fifteen-hour days and seven-day
weeks were a hardship for me, my wife, and our four young children. I remained active as a
consultant to the council, particularly on international monetary issues that had
concerned me as a member. Moreover, I was now more visible outside my profession, so I
wrote and spoke more frequently on issues and controversies of the day. But I knew that
alumni of Washington often have difficulty getting back into mainline professional
scholarship. I determined to accomplish that re-entry, and I believe I did.
Kennedy and Johnson added the war on poverty to their agenda. Walter Heller and the
council were very much involved. I became quite interested in the economic disadvantages
of blacks and in the inadequacies, inefficiencies, and perverse incentives
penalties for work and marriage of federal and state welfare programs. I wrote
major papers on these matters in 1965 and 1968. This was not macroeconomics, but one
implication of the Keynesian-neoclassical synthesis was that welfare and redistributional
policies could be, within broad limits, chosen
independently of macroeconomic goals. Nothing in our view of the functioning of
capitalist democracies says either that prosperity requires hard-hearted welfare policies
and small governments or that it requires redistribution in favor of workers and the poor.
I favored a negative income tax. So did Milton Friedman although his version
seemed to me too small to fill much of the poverty gap, and he refused to join a national
nonpartisan statement of economists favoring the approach. I helped to design a negative
income tax plan for George McGovern in 1972. Unfortunately, he and his staff botched its
presentation in the heat of the California primary; I am sure most people to this day
think McGovern was advocating a kooky budget-breaking handout. After the election Nixon
proposed a family assistance plan pretty much the same as the McGovern scheme he had
ridiculed during the campaign.
I have lived long enough to see the revolution to which I was an eager recruit fifty
years ago become in its turn a mainstream orthodoxy and then the target of
counterrevolutionary attack. The tides of political opinion and professional fashion have
turned against me. Many of my young colleagues in the profession are as enthusiastic
exponents of the new classical macroeconomics as I and my contemporaries were crusaders
against old classical macroeconomics in the 1930s. Many of the issues are the same, but
the environment is quite different from the great depression. The contesting factions are
better equipped our profession has certainly improved its mathematical, analytical,
and statistical tools. I do not despair over the present divisions of opinion in
economics. Our subject has always thrived and advanced through controversy, and I expect a
new synthesis will evolve, maybe even in my lifetime. I havent abandoned the field
of battle myself. I hope I learn from the new, but I still think and say that Keynesian
ideas about how the economy works and what policies can make it work better are relevant
today not just Keynes wrote them, of course, but as they have been modified,
developed, and refined over the last half-century.
Date of Birth
March 5, 1918
A.B. Harvard University, 1939
M.A. Harvard University, 1940
Ph.D. Harvard University, 1947
Junior Fellow, Harvard University, 19461950
Associate Professor of Economics, Yale University, 19501955
Professor of Economics, Yale University, 19551957
Sterling Professor of Economics, Yale University, 1957present
The American Business Creed (with S. E. Harris et al.)
National Economic Policy
Essays in Economics: Macroeconomics
The New Economics One Decade Older
Essays in Econometrics: Consumption and Econometrics