PROFILES OF WORLD ECONOMISTS JAMES TOBIN 25 JAMES TOBIN doc. Ing. Vladimír Gonda, CSc. Faculty of National Economy, University of Economics in Bratislava On 12 March 2002 at the age of 84 the which entities take decisions on con- Nobel laureate for economics and one sumption, production and investment. of the leading representatives of current The Nobel Prize was awarded to James neo-Keynesianism American economist Tobin just at a time when for many it was James Tobin died. He was awarded the a surprise, since the start of the Eighti- Nobel Prize for economics in 1981 for es was characterised by an intensive his portfolio theory, for analysis of the growth in conservatism and the rise of ways by which changes in financial mar- anti-Keynesianism, while Tobin was kets (i.e. on the money and financial essentially in opposition to the neo-con- markets) influence real markets, in servative approach to economic policy. James Tobin was born in 1918 in Champaign, USA. His fat- came to be a long-term interest of his. In 1947 he was elec- her was a journalist and his mother a social worker. In 1946, ted Member of the Society of Fellows. From 1950 onwards he James Tobin married Elizabeth Fay Ringo, an economics gra- worked at the School of Econometrics at Yale University. duate at MIT (Massachusetts Institute of Technology), where By the end of the Fifties James Tobin had begun to write her teacher was P. Samuelson. Together they raised four occasional articles on economic issues current at that time children – a daughter and three sons. and which were intended mainly for the lay public. In 1966 to James Tobin studied economics at Harvard University 1970 he worked as Chairman of the Planning Commission for (1935 – 1939). Many of Tobin's colleagues later became lea- the town of New Haven, though J. Tobin's main contribution in ding personalities in economics – Paul A. Samuelson, Lloyd public life was primarily his membership in the Council of Metzler, John Kenneth Galbraith, Richard Musgrave, Paul Economic Advisers to President J. F. Kennedy in 1961 – Sweezy and others. 1962. He was also an active consultant to the Council later During the Second World War Tobin worked for some time following his return to Yale. He worked at Yale University for in Washington in the Office of Limiting Civil Consumption of more than 50 years as teacher and scientist. Even following Metals and later on for four years in the US Navy. After the his retirement he continued to take an interest in current end of the war he returned to Harvard, completing his docto- developments in macroeconomics, as is documented by his rate in 1946 – 1947. His doctoral dissertation was a theoreti- books “Full Employment and Growth” and “Money, Credit and cal and empirical analysis of the consumer function, which Capital” of 1997. Modern Keynesian approaches can be held either in the form of money, bearing no to the demand for money yield (or only a minimal yield on a current account) or in the form of bonds with a positive yield. The Keynesian theory of the demand for money The Baumol-Tobin model considers the hypotheti- was elaborated in the Fifties by several authors (pri- cal individual, who receives an income paid at the marily W. Baumol and J. Tobin), who reached the start of a period and expenditures incurred evenly conclusion that not only the speculative motive of throughout the period. Income that the subject gets holding money is a function of the interest rate, but at the start of the period can be deposited to a gre- that also the transaction and precautionary motive ater or lesser extent in various assets – in the model are derived from the interest rate. J. Tobin further ela- bonds bearing a fixed income are considered. The borated also the speculative demand for money. rest of the income is used for expenditures. As soon a) The Baumol-Tobin model of the transaction as the un-saved part of the income is consumed, demand for money. bonds are periodically sold and the proceeds is In contrast to the original Keynesian approach this used to cover expenditures until the end of the peri- model proves the transaction demand for money to od. At the start of the following period the subject be dependent on the interest rate. The model as again receives income and the situation is repeated. a whole is based on the fact that income, which Each conversion (sale or purchase of bonds) is a subject retains for a period (usually one month), necessarily connected with certain transaction costs BIATEC, Volume XI, 1/2003 PROFILES OF WORLD ECONOMISTS 26 JAMES TOBIN (brokerage fees for mediating the sale, loss of time b) Portfolio selection theory. (Tobin's theory of expressed in money) and also the loss of income, the speculative demand for money) which alternative assets bear. If the subject decides J. Tobin elaborated on Keynes' theory of the spe- to hold a large amount of money, and thus converts culative demand for money and developed into non-cash assets into money less often, then expen- a form of the portfolio selection theory (the structure ses for conversion are reduced, but large opportuni- of financial assets by subjects). ty costs arise to him (the costs of a sacrificed oppor- In his portfolio theory Tobin attempted to avoid tunity), which are actually losses due to the fact that some of the weak (and criticised) points of Keynes' the money was not stored in alternative income theory - mainly the too high level of the assets. model's abstraction. A necessary shortcoming of the Conversely, if the subject decides to hold less original Keynes' analysis of speculative demand for money, then he/she will have to convert bonds to money was the claim that subjects hold all their money more often. His opportunity costs will be wealth either in the form of money or in the form of lower; on the other hand however the period, for bonds (in the case of high interest rates). It is thus which money is consumed, will be shorter and thus clear that he did not consider the possibility of diver- he will have to sell bonds more frequently, in conse- sification. quence of which costs for conversion will rise. Keynes' theory of speculative money holding The outcome? The subject behaves rationally, i.e. assumed that subjects hold only bonds, if their he/she chooses an amount of money that minimises expected yield is greater than the expected yield of total costs, which are the sum of transaction costs money (which is, according to Keynes, nil), or only (costs for conversion) and opportunity costs (loss of money, if the expected yield of bonds is less than the alternative income). expected yield of money. Only in an exceptional It is clear that the amount of money reserve case, where the expected yield of bonds as well as depends not only on income, but also on the interest of money are identical, would people hold bonds as rate which influences the level of opportunity costs. well as money. From Keynes' theory it thus results Holding bonds is more attractive for the subject when that practically no one would hold concurrently the interest rate is higher. The interest rate thus ope- money and bonds (i.e. would not hold a diversified rates indirectly proportionally not only on the specu- portfolio), which however does not correspond to lative demand for money (Keynes' position), but also reality. on the transaction component of the demand for J. Tobin attempted to counter these weak points. money. Against this brokerage costs necessary for He worked from Keynes' assumptions that subjects purchasing securities influence the transaction hold wealth in money or in bonds, where money demand for money proportionally - the higher they bears a zero yield. At the same time he elaborated are, the greater the wish to hold cash, money. The on the Markowitz portfolio theory (1952), which mathematical derivation of subject's behaviour is shows that the variability of yields (rate of risk) may shown in the following equation, which expresses the be reduced by investing in assets whose prices do transactions demand for money: not move in conjunction. J. Tobin constructed a model of the speculative b . Y demand for money for the situation when an indivi- MD = –––––– √ 2r dual considers not simply the yield of assets, but also the level of their risk. Money is an asset with in where: usual circumstances a zero yield, but also with zero b = transaction costs for intermediating a sale (inc- risk (ceteris paribus). On the other hand bonds may luding transport, loss of time) show a positive yield, but also represent a certain Y = amount of money which the subject will receive level of risk (potential loss). at the start of a given period People have different levels of aversion to risk, r = rate of return on the bond and so it is also probable that they decide to hold a certain diversified portfolio of money and bonds Synopsis: from the Baumol -Tobin model it results and not solely money or solely bonds. that the transaction demand for money is a growing On the basis of a comparison of yields and risks function of income and a declining function of the connected with various alternatives of securities hol- interest-rate. The significant finding of this model is dings and - speculative money balances Tobin crea- the conclusion that the level of the interest rate influ- ted an optimum portfolio structure model. An impor- ences money holding (also) for transaction purposes.