The American economist James Tobin was awarded the 1981 Royal Bank of Sweden Prize in Economic Science in Memory of Alfred Nobel for his contributions to monetary economics and macroeconomics (Purvis 1982; Myhrman 1982).

Among the generation of American Keynesians who came to economics in the 1930s and 1940s, which included his fellow Nobel laureates Paul Samuelson, Robert Solow, Lawrence Klein and Franco Modigliani, Tobin stood out for his exploration of the working of the monetary system and especially of the transmission mechanism through which monetary policy affects the real economy (Tobin 1980, 1971-96; Purvis 1991; Buiter 2003; Dimand 2014).

Tobin’s contributions ranged from models of the transactions demand for money (Tobin 1956) and demand for money as a store of value (Tobin 1958b) to the extension of the investment saving-liquidity preference money supply (IS-LM) macroeconomic framework to multi-asset portfolio balance models (Brainard and Tobin 1968; Tobin 1969, 1982a), introducing money in long-run growth theory (Tobin 1965), and scepticism about the macro efficiency of the financial system (Tobin 1984). Within the economics profession, he was best known for Tobin’s q theory of investment (Tobin’s q is the ratio of the market value of equity to the replacement cost of capital; Brainard and Tobin 1968), Tobit estimators for limited dependent variables (Tobin 1955b, 1958a), and the Tobin separation theorem (Tobin 1958b: if a riskless asset exists, differing degrees of risk aversion just affect the fraction of the portfolio to be placed in risky assets, but do not change the optimal combination of risky assets). Beyond the economics profession, he was famed for the Tobin tax, a proposed small tax on international currency transactions to inhibit speculative “hot money” flows (Tobin 2003; Haq et al. 1996). His contributions to economics beyond monetary economics included pioneering work in “green accounting” to move beyond gross domestic product (GDP) to a Measure of Economic Welfare (Nordhaus and Tobin 1972) and in the creation of neoclassical growth theory (Tobin 1955a; Solow 1956; Swan 1956).

Describing himself as an “Old Keynesian” (Tobin 1993) rather than a new, neo- or post-Keynesian, Tobin served on President Kennedy’s Council of Economic Advisors and argued for activist macroeconomic stabilization policies and for income redistribution to fight poverty (see essays collected in Tobin 1989, 1996). “Tobin’s way of combining rigor and relevance, intelligence and passion, theory and common sense, has stayed green in my memory for more than 40 years,” wrote Robert Solow (2004: 658).

James Tobin was born on 5 March 1918, in Champaign-Urbana, Illinois, to a journalist, who later handled publicity for the University of Illinois Athletic Association, and a social worker. After attending the university’s experimental high school, Tobin went to Harvard on a scholarship in 1935, receiving his BA in 1939, his MA in 1940, and his PhD, after a year working in Washington and then wartime service in the US Navy, in 1947. When Tobin took Ec A (Principles of Economics),

[t]he same crazy graduate student [Spencer Pollard] who was my Ec A instructor was also my tutor... My tutor wanted us to read “this new book that people are saying is important” [Keynes 1936]... I found it pretty exciting because this whole idea of setting up a macro model as a system of simultaneous equations appealed to my intellect... So my introduction to economics, taking the elementary course and reading Keynes, were simultaneous in my sophomore year. (Interview in Shiller 1999: 870)

Coming to economics by reading Keynes’s General Theory, and hearing his mother’s experiences as a social worker in the Depression, shaped Tobin’s approach to macroeconomics as a discipline relevant to public policy and the real world, not just intellectual puzzle-solving.

Tobin’s PhD dissertation (1947a) investigated why the simple Keynesian consumption function, which showed an almost perfect fit between aggregate consumption and aggregate disposable income in the interwar United States, failed to predict the post-war surge in consumption.

His main contribution in his thesis, adding wealth as an argument in the saving function, was published as Tobin (1951) and added an inter-temporal dimension to modelling of consumption and saving - the implications of Irving Fisher’s 1907 two-period optimal consumption diagram were not then generally recognized. As Willem Buiter (2003: F609) observes, section 3.3 of Tobin (1952), “The public debt as private wealth,” considered the possibility of what is now called debt neutrality or Ricardian equivalence, but Tobin (like David Ricardo) considered this unlikely to hold in practice. As late as the 1960s, Tobin was invited to contribute to the International Encyclopaedia of the Social Sciences as an authority on the consumption function, rather than as a monetary economist. But even as a graduate student, Tobin worked in monetary economics, making Keynes’s liquidity preference function operational and estimating its parameters (Tobin 1947b). Hansen (1949), source of what became known as the Hicks-Hansen IS-LM diagrams, “relied heavily upon [Tobin’s] analysis” (and on Hicks 1937) in the more technical parts of the book, and Tobin was the only person Hansen thanked for prepublication comments (Hansen 1949: vi, 126 n., 168n).

After his PhD, Tobin was elected to a three-year term in Harvard’s Society of Fellows, with no responsibilities except his own research. He spent the last of those academic years, 1949-50, visiting Richard Stone’s Department of Applied Economics in the other Cambridge. Tobin (1950) pioneered pooling aggregate time-series data with crosssection budget studies to estimate the demand for food in the United States, a landmark study that held up well when revisited by later econometricians using current methods (Magnus and Morgan 1999). Noting that in any data for purchases of consumer durables (such as automobiles), most observations would be zero (most households do not buy a car in any given year), Tobin (1955b, 1958a) extended probit analysis to examine simultaneously the decision whether to spend and how much to spend, a procedure econometrician Arthur Goldberger named Tobit analysis.

Tobin joined Yale University as associate professor in 1950 (full professor from 1955, Sterling Professor of Economics from 1957), retiring in 1988 but teaching undergraduate courses for another decade and remaining active in research until his death on 11 March 2002. He won the American Economics Association’s John Bates Clark Medal, for an outstanding American economist below the age of 40, in 1955, and was president of the Econometric Society in 1958. After Tobin declined to move to the University of Chicago to succeed Tjalling Koopmans as director of the Cowles Commission, Koopmans and Cowles moved to Yale with Tobin as the first director of the renamed Cowles Foundation for Research in Economics.

Tobin (1956, 1958b) asked why rational agents hold fiat money yielding zero interest when bonds paid strictly positive nominal returns. Like Baumol (1952), Tobin (1956) modelled transactions demand for money as an optimizing trade-off between transactions cost of selling bonds for money to make payments and interest foregone by holding cash instead of bonds. The resulting square root rule, familiar in the literature on inventories, had been derived by Maurice Allais (1947: 238-41, translated in Baumol and Tobin 1989), but this was ignored by English-speaking economists. Drawing on Harry Markowitz’s concept of an optimally diversified portfolio that minimized risk for any given level of expected return (Markowitz 1952), Tobin (1958b) modelled demand for money as an asset as a trade-off between expected return and risk (measured as the mean and variance, respectively, of the distribution of returns on an efficient portfolio of risky assets), solving for the fraction of the portfolio to be held as riskless, zero-return money. Whereas Keynes (1936) assumed that each investor held a different point-expectation of returns, so each investor held either all cash or all securities, Tobin (1958b) posited that investors share a probability distribution over expected returns, so that a change in the interest rate would cause each investor to hold a slightly larger or smaller proportion of his or her wealth as money, rather than some investor switching entirely between money and securities while others did not adjust their portfolios at all.

Markowitz (1952) examined how a rational investor should act, Tobin (1958b) the money demand function and asset market equilibrium that would result from investors following Markowitz’s prescription.

On sabbatical in 1958, Tobin began a comprehensive statement of his approach to monetary theory that four decades later became Money, Credit and Capital (Tobin with Golub 1998). Tobin’s account of endogenous creation of money through optimizing portfolio choices of commercial banks facing risk (Tobin 1982b; Tobin with Golub 1998:ch. 7) was a part of that manuscript that was completed by 1960. The project was interrupted when President-elect John F. Kennedy chose Tobin for the President’s Council of Economic Advisers. “I remember your protesting, in our telephone conversation prior to your appointment, that you were an ‘ivory tower’ economist,” recalled Kennedy when Tobin left the Council (Yale University Library, Manuscripts and Archives 1999 [2010]: Kennedy to Tobin, 12 July 1962, Tobin Papers 2004-M-088, Box 7):

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 economic 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... Your advice, whether from within or without the Government, will always be received with interest and respect in this Administration.

Tobin (1955a) was a founding contributor to neoclassical growth theory. Like Pilvin (1953), Solow (1956) and Swan (1956), Tobin (1955a) eliminated the knife-edge instability property attributed to Harrod-Domar growth models by allowing smooth substitution between capital and labour instead of fixed proportions in production. However, Tobin (1955a) was overshadowed by Solow (1956) and Swan (1956), partly because Tobin’s paper did too many things at once, for example, introducing portfolio substitution between money and capital in long-run growth, and considering long-run growth in a model with unemployment due to a rigid money wage.

Trying again, but making one contribution at a time, Tobin (1965) argued that monetary policy has long-run nonneutral effects through capital intensity even if full employment is assumed. While Tobin (1965) treated money and capital as substitutes in portfolios, so that faster increase of the nominal money supply and price level (raising the opportunity cost of holding real money balances) would increase capital intensity, Stanley Fischer and others later modelled money and capital as complementary factors inputs for firms (see Dimand 2014). While money is thus not necessarily neutral even in the long run without price or wage rigidities, the direction of the non-neutrality is sensitive to how the model is specified. Nordhaus and Tobin (1972), a founding work of “green accounting”, stressed the growth of a Measure of Economic Welfare rather than growth of GDP.

Tobin (1974, 1978, 2003) proposed a small tax on international currency transactions to curb speculative capital flows that inhibit use of national demand management to stabilize employment and output (Keynes 1936: 160, proposed a small tax on stock market trades to limit speculation). Such a small tax would have inconsequential effects on trade in goods and services and on long-term direct and portfolio investments, but would cumulate on high-frequency short-term “hot money” flows: “A tax of 0.05 per cent is negligible, for a one-time transfer but, if paid once a week, it cuts 2.5 percentage points off the annual rate of return and much more off the yield of day trading” (Tobin 2003: 62 - automated trading algorithms now trade at much higher frequencies). To Tobin’s dismay, he was acclaimed by opponents of globalization: two of the pieces reprinted in Tobin (2003) are entitled “They are misusing my name” and “An idea that gained currency but lost clarity”. Similarly, Jagdish Bhagwati has been lionized by advocates of globalization, yet Tobin and Bhagwati agreed in supporting free trade in goods and services while wishing to control short-term capital flows (Dimand 2014).

Encountering economics through Keynes and the Depression, Tobin rejected the natural rate hypothesis of Milton Friedman (1968) that the economy would be at the natural rate of unemployment in the absence of unexpected inflation and that reducing unemployment below the natural rate involves fooling people into giving up valuable leisure for lower real wages than they think they are getting (see Friedman and Tobin in Gordon 1974; also Tobin 1980; Lucas 1981). Inspired by Irving Fisher (1933) as well as Keynes (1936: ch. 19), Tobin (1975, 1980, 1993, 1997) argued that, because aggregate effective demand depends on (expected) inflation as well as on the price level, the economy is only self-adjusting within a corridor of stability (Palley 2008; Bruno and Dimand 2009). In Tobin’s model, the economy returns automatically to potential output after small shocks, but large negative demand shocks push the economy outside the corridor, moving further away from full employment unless government policy introduces an offsetting demand shock - that is, Great Depressions are possible. In such a model faster adjustment of prices and money wages can be destabilizing.

Tobin’s q theory of investment made net investment depend on q, the ratio of the market value of equity to the replacement cost of capital (Brainard and Tobin 1968), providing a channel for monetary policy (and stock market bubbles and crashes) to affect investment by changing asset prices (see also Tobin 1961). If q exceeds one, net investment is positive and the capital stock grows. If q is less than one, it is more profitable for firms to buy existing assets than to invest in creating new ones, so gross investment is less than depreciation, and net investment is negative. At q = 1, the capital stock is at its desired level. Since asset prices were the channel through which monetary policy could affect real investment, Tobin (1969, 1982a) turned to the determination of asset prices through his “general equilibrium approach to monetary theory,” with money as one of several assets that are imperfect substitutes for each other. Money differs from other assets by having an institutionally fixed nominal return. Hicks (1935) crucially influenced Tobin’s approach. The later new classical usage of “general equilibrium” refers to markets linked through the budget constraint of a representative agent (or in overlapping-generations models, two agents, one old and one young). For Tobin “general equilibrium” implied market linked by the adding-up constraint that asset demands had to sum to total wealth and that stocks and flows had to be consistent. Tobin developed choice-theoretic foundations of each component of aggregate demand: consumption (Tobin 1947a, 1951), investment (Tobin’s q), money supply (Tobin 1982b), and money demand and portfolio balance (Tobin 1956, 1958b).

Keynesian macroeconomics lost ground to monetarism, new classical economics, and real business cycle theory in the 1970s and even more in the 1980s for several reasons: greater concern with inflation rather than unemployment, emphasis on long-run growth of potential output rather than short-run stabilization, instability of parameters in large macro-econometric models used for forecasting and policy evaluation, conservative shifts in the political environment. In addition, correlation among the many, imperfectly substitutable assets in the multi-asset modelling approach of Tobin (1969, 1982a) led to high standard deviations and low t-statistics in attempts at empirical implementation such as Backus et al. (1980), while, as Tobin noted (in Shiller 1999: 889), “The whole idea of modern finance does not include imperfect substitution. I suppose in defense of ignoring it is the fact that we weren’t actually able to solve the nonlinear equations with these adjustment mechanisms.” Recent events, showing that depressions and financial crises can still happen in advanced industrial countries, suggest renewed relevance for the corridor of stability of Tobin (1975, 1980, 1993, 1997) as a middle ground between models that automatically re-adjust to a unique full employment equilibrium, not matter how large the shock, and models that are always unstable - particularly since Tobin’s result does not depend on wage rigidity but only on noting that aggregate demand depends on the rate of change of prices as well as on the level (see also Fisher 1933; Keynes 1936: ch. 19). Beyond his role as an “Old Keynesian” in macroeconomic debates (for example, the corridor of stability) and public policy (for example, the Tobin tax), Tobin’s contributions to economics range from Tobin’s q and his modelling of money demand and endogenous money creation to the Tobit estimator, pooling of time series and cross-section data, the Tobin separation theorem in portfolio choice, and his role in the creation of the capital asset pricing model (CAPM) and the neoclassical growth model.

Robert W. Dimand

The American economist James Tobin was awarded the 1981 Royal Bank of Sweden Prize in Economic Science in Memory of Alfred Nobel for his contributions to mon­etary economics and macroeconomics (Purvis 1982; Myhrman 1982).

More on the topic The American economist James Tobin was awarded the 1981 Royal Bank of Sweden Prize in Economic Science in Memory of Alfred Nobel for his contributions to mon­etary economics and macroeconomics (Purvis 1982; Myhrman 1982).:

The American economist James Tobin was awarded the 1981 Royal Bank of Sweden Prize in Economic Science in Memory of Alfred Nobel for his contributions to monetary economics and macroeconomics (Purvis 1982; Myhrman 1982).

More on the topic The American economist James Tobin was awarded the 1981 Royal Bank of Sweden Prize in Economic Science in Memory of Alfred Nobel for his contributions to monetary economics and macroeconomics (Purvis 1982; Myhrman 1982).: