So long, Milton Friedman. Hello, James Tobin.
After a three-decade run, the free-market philosophies of Friedman that shaped US policy are being eclipsed by the pro-government ideas of Tobin, the late Yale economist and Nobel laureate who brought John Maynard Keynes into the modern era.
Tobin’s stamp is on the $787 billion stimulus signed by President Barack Obama, former students and colleagues say. His philosophies are influencing Austan Goolsbee, a former Tobin student advising Obama, and Ben S Bernanke, head of the Federal Reserve. Unlike Friedman, Tobin provides guidance for today’s problems, said Paul Krugman, a Princeton University economist.
“Hard-line doctrines don’t seem very appropriate at this troubled moment,” said Krugman, a New York Times columnist who also worked with Tobin at Yale from 1977 to 1979. “Tobin was never a guru in the way Milton Friedman was; he never had legions of Samurai ready to spring to the defense of his theories, but that’s part of why he is so relevant right now.”
The decision by Bernanke last year to invoke the Fed’s emergency powers and put mortgages and other assets on the central bank’s balance sheet “is pure Tobin,” Krugman said. Bernanke cited Tobin’s 1969 essay on monetary theory in a 2004 paper discussing options available to the Federal Reserve for stimulating the economy when interest rates approach zero.
Tobin’s experience of the depression as a teenager in the 1930s gave him a lifelong loathing of unemployment.
‘Livid’ Response: “As a young professor I did a paper where I analyzed the optimal unemployment rate,” said Joseph Stiglitz, a professor at Columbia University in New York, who knew Tobin at Yale. “Tobin went livid over the idea. To him the optimal unemployment rate was zero.”
Like Keynes, Tobin was an advocate for the role of government in maintaining full employment, said James Galbraith, an economist at the University of Texas in Austin. The current economic and financial crisis has validated that philosophy, said Galbraith, a former Tobin student and the son of the late John Kenneth Galbraith, who was a friend of Tobin.
“It’s clear that the position that the federal government has a responsibility for the level of employment, for the economy, has prevailed,” Galbraith said. “The position that the Fed can walk away from the level of employment has completely collapsed. That was the absolutely dominant position coming out of the University of Chicago.”
In contrast to the Friedman-influenced proponents of tax cuts, deregulation and tight control of the money supply, followers of Tobin are more receptive to government intervention in the economy, including stimulus spending.
Herbert Hoover: “I do not believe that over the next two years, we can make major deficit reduction or balancing the budget a goal,” Goolsbee, nominated by Obama to the Council of Economic Advisers, said at a Senate hearing on January 15. “I think that would run the risk of repeating one of the mistakes of Herbert Hoover that led us into Depression.”
Goolsbee was Tobin’s research assistant at Yale.
Tobin was born in 1918 in Champaign, Illinois, the son of a former reporter who was a publicist for the University of Illinois football team. His high school years during the depression motivated him to study economics at Harvard University in Cambridge, Massachusetts, Tobin said in an essay written for the Nobel committee.
“The miserable failures of capitalist economies in the Great Depression were root causes of worldwide social and political disasters,” he wrote. Economics “offered the hope, as it still does, that improved understanding could better the lot of mankind.”
Nobel Winners: Tobin, who died in 2002, won the 1981 Nobel Memorial Prize in Economic Sciences for his analysis of the effect of financial markets on inflation and employment. His followers have been honored as well. Krugman won the 2008 prize, for work on international trade and economic geography. Stiglitz shared the 2001 award, which cited analyses of markets in which some participants have much better information than others.
Tobin helped pioneer the study of financial markets and their importance to economic performance, said William Brainard, a Yale colleague and friend.
“He believed financial markets could serve a valuable service in diversifying risk and moving capital in efficient ways,” Brainard said. “But he was not someone who believed the market always got it right and that private incentives were always aligned with the public good.”
Keynes, who died in 1946, was the British economist whose ideas helped shape U.S. policies for more than four decades, beginning in President Franklin D. Roosevelt’s New Deal.
Discredited Idea?
Not all economists accept that Tobin’s theory of government intervention has replaced the Friedman model.
John Cochrane, a finance professor at the Booth School of Business at the University of Chicago, said that while Tobin made contributions to investing theory, the idea that spending can spur the economy was discredited decades ago.
“It’s not part of what anybody has taught graduate students since the 1960s,” Cochrane said. “They are fairy tales that have been proved false. It is very comforting in times of stress to go back to the fairy tales we heard as children but it doesn’t make them less false.”
To borrow money to pay for the spending, the government will issue bonds, which means investors will be buying U.S. Treasuries instead of investing in equities or products, negating the stimulative effect, Cochrane said. It also will do nothing to unlock frozen credit, he said.
‘Tobin Tax’
Tobin proposed taxing financial transactions to slow the flow of money to and from markets. Tobin worried that too much efficiency would create instability in the markets as transaction costs fell, said Stiglitz. While there was a flurry of interest in what became known as the “Tobin Tax” during the Asian financial crisis of the late 1990s, the idea never received political support.
Tobin’s understanding of the role of financial markets in the economy was rooted in his study of the decisions made by investors, and he was the intellectual force behind many of the tools they use today, Stiglitz said.
He devised the Q Ratio, a formula that divides total market capitalization by the cost of replacing assets. Q of greater than one suggests a fast-growing company with incentive to make new capital investments; a Q lower than one suggests a company that might be ripe for takeover because buying its shares would cost less than replacing its assets.
“He’s the father of modern asset pricing,” Stiglitz said.
After Harvard, where he studied under the late Joseph Schumpeter, he spent four years in the U.S. Navy, serving on a destroyer that supported the invasion of North Africa.
Wouk Character
While training to be an officer, he served with Herman Wouk, who later wrote “The Caine Mutiny.” Tobin was Wouk’s model for a character called Tobit, a “mandarin-like midshipman” who had “a domed forehead, measured quiet speech and a mind like a sponge.”
Tobin began teaching at Yale, in New Haven, Connecticut, in 1950, leaving in 1961 and 1962 to serve on the U.S. Council of Economic Advisors under President John F. Kennedy.
At Yale, he put his stamp on generations of economists who studied or taught there. Those include Goolsbee, Krugman, Stiglitz, and Galbraith. Others influenced by Tobin at Yale include Robert Shiller, a Yale economist and creator of the Case/Shiller home price index; Nouriel Roubini, the New York University economist who predicted the financial collapse; Janet Yellen, president of the Federal Reserve Bank of San Francisco; and David Swensen, Yale’s investment manager.
Levin’s Wish
Tobin’s influence on today’s policy makers is still not as powerful as former students would like to see. Richard Levin, the president of Yale, said Tobin would have wanted the stimulus package to create more jobs and contain fewer tax cuts.
“Tobin’s insights are what’s needed right now,” Levin said. “I wish policy makers would listen more carefully to Tobin.”
To contact the reporter on this story: Oliver Staley in New York at ostaley@bloomberg.net; Michael McKee in New York at mmckee@bloomberg.net.
