Portfolio Balance, Money Demand, and Money Creation

Tobin’s doctoral dissertation dealt with consumption and saving decisions, and the articles based on that dissertation (together with his econometric papers on food demand and rationing) put him on the path to receiving the John Bates Clark Medal in 1955, awarded by the American Economic Association every two years to an American economist under the age of 40 who has already made significant contributions to knowledge (the only previous winners were Paul Samuelson, Kenneth Boulding, and Milton Friedman). But in the late 1950s and the 1960s, Tobin’s main research interest turned from understanding saving (the S of the IS curve) to exploring the optimizing microeconomic foundations of the money demand (liquidity preference), money creation and asset market equilibrium underlying the LM (liquidity/money) curve, which lead to his writing some of his most influential articles (Tobin 1956, 1958a, 1961, 1963). Although the analysis in these articles was theoretical, Tobin was well aware of the policy relevance of the nature of the money demand function. Already in 1947 (in an article also noteworthy for its empirical estimation of a money demand function depending on income and interest), Tobin opened a critique of an article by pioneer monetarist Clark Warburton and of a book by William Fellner (later Tobin’s colleague at Yale) by declaring, “The contention of this paper is that the demand for cash balances is unlikely to be perfectly inelastic with respect to the rate of interest, and that policy conclusions which depend on the assumption that the demand for cash balances is interest inelastic are therefore likely to be incorrect” (1947–48, in Tobin 1971–1996, Vol. 1, p. 27, cf. Fellner 1946 and the articles collected in Warburton 1966).