Knowledge that Transforms

LN I935 and I936 American families paid out each year about 2.8 billion dollars for net life insurance premiums. In estimating the saving of American families for I935-36, the National Resources Committee 1 assumed that ioo per cent of such premiums constitute saving. Dr. Rufus S. Tucker has criticized this assumption,2 stating that it is not correct since part of the payments go to cover current protection and costs of collection and administration. After consultation with insurance experts, Tucker estimated that instead of ioo per cent, the proportion of such premiums that add to saving was 67 per cent in the case of families with incomes over $2500 a year, 62'2 per cent in the case of families with incomes between $I500 and $2500, and 6o per cent in the case of poorer families. It is true that of the 2.8 billion dollars paid for net premiums about i.o billion went to pay death losses in excess of reserves and to cover other costs. However, Tucker neglected to take account of interest credited to policy-holders during this period which amounted to about 0.7 billion dollars. The increase of assets of the policy-holders was then 2.5 billion dollars, or nearly 90 per cent of net premium payments to the insurance companies. This percentage is closer to that assumed by the N. R. C. than to that assumed by Tucker, which averaged about 6 I per cent. On the other hand, as Tucker pointed out in a letter to the author, if insurance interest is included in saving (as it certainly should be), it should presumably be included in income; 3 and this the N. R. C. failed to do. However, the omission of this item from income of individuals makes a difference of only i per cent, whereas its omission from saving makes a difference of about iO per cent. The proportion of a given insurance premium that constitutes saving depends, of course, upon the type of policy, the age of the insured at issue, the age of the policy, the interest rate, and also upon the Company. For any particular case the proportion is simply the ratio of the increase in cash value, as given in the policy, to the net annual premium. I am indebted to B. F. Blair, Actuarial Assistant to the Provident Mutual Life Insurance Company, for the following figures for the ratio of increase in cash value during 1936 to net annual premium, for policies issued 5, io, and 20 years previously to men 25, 35, and 45 years old:

N a note in Econometrica,2 in I942, the author sketched a new approach to the theory of business fluctuations. He claimed that this was the approach in a mathematical sense, as defined by Jeffreys.3 It also can be considered as the simplest possible dynamic generalization of the Walrasian system of general equilibrium. Roughly speaking, the simple theory explains business fluctuations as resulting from the existence of interrelated markets. The buyers and sellers on these markets react not to existing prices but to anticipated prices. All functional relationships involved are assumed to be linear (as first approximations). If anticipations of the buyers and sellers are asymmetrical in a certain well defined sense, then there is the possibility of periodic fluctuations in prices and quantities. These magnitudes will fluctuate with the same period but with various amplitudes (which may be constant, damped, or exploding) and with leads and lags. Such a movement of prices and quantities is essentially what we mean if we speak of the business cycle.4 It is not claimed, of course, that this is in all cases the only possible explanation of booms and depressions. The author has indicated in an earlier publication that a variety of causes may be at work in creating these fluctuations.5 But it is possible that these speculative fluctuations are able to explain some of the cyclical phenomena met with in our economy.6 Strictly speaking, our theory would require a study of all or at least the most important markets. Such a study is not feasible because of the amount of computational work, which, as will be seen, is very great even with only three variables. We, therefore, shall limit ourselves to the most important markets and shall use for our verification data for stock prices, farm prices, and prices of nonfarm commodities, covering the period I920-42. All the series are in the form of index numbers; we hope that this fact does not unduly distort the picture. A model based upon our theory will be constructed and the unknown parameters determined by various methods, keeping always in mind the relationships necessarily implied by our theory.7 The fitted functions will be subjected to certain statistical tests in the final sections of this paper.8 Such a procedure cannot, of course, afford a complete test of the theory. Even if the statistical test were completely applicable, the model used is not unique for our theory. All that can be said is that ours is the simplest theory which will lead to the specific model.