Observatory · Economic theory
Franco Modigliani is the only Italian to have received the Nobel Prize in economics, awarded in 1985 with a citation that deserves to be read again word by word: for his pioneering analyses of saving and of financial markets. These are precisely the two grounds on which a productive system's ability to fund itself is decided, and yet his ideas seem forgotten in the very country where he was born.
The life-cycle hypothesis, which Modigliani developed from the 1950s onwards, rests on an intuition so simple that it is hard to refute: over a lifetime an individual seeks to spread consumption as evenly as possible, constrained by the resources they expect to command in total. People do not consume in proportion to this month's income, but in proportion to what they believe they can earn across their lifetime. It follows that they save during the years of full productive capacity in order to consume when that capacity declines.
From this premise follows a concrete model of economic life: stable employment allows the purchase of a home, saving funds consumption concentrated in particular periods, accumulated wealth passes to the next generation. It is a model that describes with precision the behaviour of Italian households for much of the post-war period, and it is also the reason why Italian private saving long represented one of the soundest asset bases in Europe.
A public system that wants to support this mechanism cannot limit itself to containing expenditure. It must guarantee investment in enterprise, research, education and health, because these are the conditions that make predictable the expected income on which the whole cycle rests. In this perspective public spending is not by definition a cost: it is when it funds current consumption, it is not when it produces patents, skills and preventive healthcare, that is to say returns deferred over time.
Those who work in corporate finance know Modigliani for a second reason, cited far less often than the first in public debate and directly relevant here. Together with Merton Miller, Modigliani showed that, in a perfect market and in the absence of taxes, distress costs and information asymmetries, the value of a firm does not depend on how it is financed. The proposition is known as the Modigliani-Miller theorem and is frequently misunderstood, because its value lies not in the conclusion but in the assumptions.
Read correctly, the theorem is a map of the points where financial structure genuinely matters: it matters because taxes exist, because distress has a cost, because lenders and borrowers do not hold the same information. All of structured finance lives precisely in these imperfections. Segregating an asset in a dedicated vehicle makes sense because it reduces information asymmetry and isolates the originator's distress risk; tranching makes sense because it allows each investor to be sold the risk profile they are able to price. Anyone proposing structures while skipping this step is selling architecture without foundations.
The life-cycle hypothesis is in tension with an economic policy framework built around budget discipline alone. The mechanism is well known and works in stages: rising interest rates make fixed income more attractive than equity investment, demand for shares contracts, the value of household financial wealth falls, and since consumption depends on expected wealth and not on current income alone, consumption declines. The contraction in demand then passes through to corporate investment, which is postponed precisely when the cost of money already makes it more onerous.
The point is not whether sound public finances are a legitimate objective, because they plainly are. The point is that a framework treating every outlay as a cost and every deficit as a fault removes from view the distinction, central for Modigliani, between spending that consumes resources and spending that produces them. That removal is paid for in decades, not quarters, because it acts on the very formation of the expected income around which households build their decisions.
For those working on corporate funding the lesson is operational, not academic. If bank credit contracts in phases of restrictive monetary policy, and contracts indiscriminately, hitting sound companies too, then diversifying funding sources is not an exercise in sophistication but a measure of resilience. And if the value of a firm depends on its financial structure precisely because of the imperfections Modigliani and Miller isolated, then building that structure with care is a lever of value, not a compliance task.
A first version of this contribution was published by the author on LinkedIn on 22 February 2025. The text has been taken up and expanded here, in particular in the part concerning the Modigliani-Miller theorem and its implications for structured finance.