About the Prize in Economic Sciences 1981
James Tobin
13 October 1981
THIS YEAR's PRIZE IN ECONOMICS AWARDED FOR
RESEARCH ON THE
FINANCIAL SYSTEM AND ITS EFFECTS ON INFLATION AND
EMPLOYMENT
The Royal Swedish Academy of Sciences has decided to
award the 1981 Alfred Nobel Memorial Prize in Economic Sciences
to
Professor James Tobin, Yale University, USA,
for his analysis of financial markets and their relations to
expenditure decisions, employment, production and
prices.
James Tobin's Principal Achievements
James Tobin's achievements cover a broad spectrum of
economic research. He has made substantial contributions in such
widely differing areas as econometric methods and strictly
formalized risk theory, the theory of household and firm
behaviour, general macro theory and applied analysis of economic
policy. His most outstanding and significant research
contribution, for which he has been awarded the Nobel Memorial
Prize in Economics for 1981, belongs to the theory of financial
markets and their relation to consumption and investment
decisions, production, employment and prices.
Tobin's most important contributions are based on a theory which
describes how individual households and firms determine the
composition of their assets. This theory, of which he is one of
the foremost originators, is known as portfolio selection theory.
Tobin has developed these ideas into a general equilibrium theory
for financial and real assets and analyzed the interaction
between financial and real markets. An essential component in
this analysis is the study of transmission mechanisms which
transfer changes on financial markets to households' and firms'
expenditure decisions. This classic problem in economic research
had, thus far, not been dealt with satisfactorily and
conclusively. Tobin's studies constitute a major breakthrough in
the integration of real and financial conditions in central
economic theory.
Portfolio Selection Theory
Portfolio selection
theory is used to study households' and firms' decisions to hold
different real and financial assets, and, simultaneously, incur
debts. Tobin shows how these decisions are governed by weighing
risk and expected rate of return. Unlike many other theorists in
the field, Tobin does not confine his analysis solely to money,
but considers the entire range of assets and debts.
Other economists who have contributed to portfolio selection
theory have mainly been concerned with indicating rules for
rational investment decisions. Tobin has aimed at providing a
basis for understanding how subjects actually behave when they
acquire different assets and incur debts. The direct result is a
description and analysis of financial markets and flows in the
economy. The primary ambition is to bring out the important
components which have, thus far, been lacking in the analysis of
impulses from financial to real markets.
The Relation between Financial and Real Markets - or the
"Transmission Mechanism"
Tobin emphasizes the effect of financial events on the demand for
real assets, i.e., investments and consumer demand. In
this context, he has pursued two fundamental issues. The first is
how monetary and fiscal policy measures, such as changes in tax
rates or central bank purchases and sales of government bonds and
treasury bills, affect national income - the "transmission
mechanism". The second concerns the factors which determine how a
change in nominal national income brought about through monetary
and fiscal policy measures will be distributed among changes in
production volume and in price level. In order to answer the
latter question, Tobin turned his attention to the problem of
wage formation. Owing to rigid wages in the short run, changes in
demand on the commodity and labor markets lead to variations in
employment rather than changes in price level and the inflation
rate. Rigidity in wage formation also makes it difficult, in
practice and in the short run, for households and firms to adjust
their plans in accordance with new information. This is the
reason why the theory of "rational expectations", which is based
on the possibility for this kind of adjustment and has grown so
important in the current economic policy debate, has been highly
criticized by Tobin.
By examining a broad spectrum of assets and debts, Tobin's
analysis of the transmission mechanism extends the channels of
contact between financial markets and real expenditure decisions
as compared to the studies of other researchers who have dealt
with similar questions. According to Tobin, the effects do not
arise through a "general" interest rate level or a money stock
defined in some way but through the financial structure as a
whole. Various institutional conditions are also taken into
account. One of the most important aspects neglected by earlier
researchers is the condition whereby the financial system is not
comprised mainly of banks, but of numerous and diverse
institutions with varying portfolio selection policies.
By designating the channels of contact between financial and real
phenomena, Tobin has indicated, theoretically and empirically,
the effects of changes in the real value of financial assets on
the volume of consumption. A particularly important aspect is the
analysis of factors that affect firms' real investments. Tobin
has succeeded in reformulating an earlier hypothesis that these
investments are strongly affected by the relation between the
market value of existing real capital and the acquisition cost of
corresponding, newly-produced real capital. If the prices of
existing real capital, such as share prices, decline when the
acquisition costs of new real capital are given or rising, then
investments are counter-acted. This relation is confirmed by
recent development in several countries.
On the basis of his examination of the financial system and
transmission mechanisms, Tobin has carried out thorough analyses
of economic conditions and stabilization policy during recent
decades. The significance of Tobin's portfolio selection theory
and analysis of financial markets is heightened by the fact that
they have proved useful in areas which he had not conceived of
when he constructed his theory. One pertinent example is the
explosive trend in the analysis of balance of payments and
exchange rates during the 1970s which is partly based on Tobin's
model.
Tobin's Influence
Tobin's creative and extensive work on the analysis of financial
markets and the transmission mechanisms between financial and
real phenomena has unquestionably inspired substantial research
during the 1970s on the effects of monetary policy, the
implications of government budget deficits and stabilization
policy in general. The lively and qualified research in progress
in these areas is, to a large extent, based on Tobin's
fundamental contributions. His efforts have also initiated
research in related fields such as balance-of-payments analysis
and the study of economic growth. Tobin's contributions will, in
all probability, continue to stimulate economic research for a
long time to come. Few economic researchers of today could be
said to have gained so many followers or exerted such influence
on contemporary research.
