Modigliani was born on 18 June 1918, in Rome, Italy, to the Jewish Italian family of a pediatrician father and a voluntary social worker mother.

He entered college at the age of seventeen, enrolling in the faculty of Law at the University of Rome. A few years before, in 1936, his submission to a nation-wide contest in Economics, sponsored by the official student organization of the state, had won first prize and Modigliani received an award from the hand of Benito Mussolini. Among his early works in fascist Italy was an article about the organization and management of production in a socialist economy, written in Italian and arguing the case for socialism along lines laid out by earlier market socialists like Abba Lerner and Oskar Lange.

In 1939, while they were in Paris, after having left Italy, Modigliani married Serena Calabi. They had two children, Andre and Sergio Modigliani. Their grandchildren were Leah, Julia, David, and Amelia, and their great-grandchildren Micaela, Sophia, Serena, and Chiara. When Franco Modigliani took the job at MIT, the couple bought a home on North Road overlooking Vineyard Sound, near Chilmark, where they lived for the rest of their lives.

From 1942 to 1944, Modigliani taught at Columbia University and Bard College as an instructor in Economics and Statistics. In 1946, he became a naturalized citizen of the United States. In 1948, he joined the University of Illinois at Urbana-Champaign faculty. From 1952 to 1962, he was a member of the Carnegie Mellon University faculty.

Modigliani, from the 1950s, is the originator of the life-cycle hypothesis, which attempts to explain the level of saving in the economy. In the hypothesis it is proposed that consumers aim for a stable level of consumption throughout their lifetime (for Example by saving during their working years and then spending during their retirement).

The Rational Expectations Hypothesis is considered by economists to originate in the later-considered "seminal" paper written by Modigliani and Emile Grunberg in 1954.

When he was a member of the Carnegie Mellon University faculty, he formulated in 1958, along with Merton Miller, the Modigliani–Miller theorem for corporate Finance. The theorem posits that, under certain assumptions, the value of a firm is not affected by whether it is financed by equity (selling shares) or by debt (borrowing money), meaning that the debt-to-equity ratio is unimportant for private firms.

Late in his life, Modigliani became a trustee of the Economists for Peace and Security organization, formerly "Economists Allied for Arms Reduction" and was considered an "influential adviser": in the late 1960s, on a contract with the Federal Reserve, he designed the "MIT-Pennsylvania-Social Science Research Council" model, a tool that "guided monetary policy in Washington for many decades."

In 1962, he joined the faculty of MIT, as an Institute Professor.

In 1975, Modigliani, in a paper whose co-author was his former student Lucas Papademos, introduced the concept of the "NIRU", the non-inflationary rate of unemployment, ostensibly an improvement over the "natural rate of unemployment" concept. The terms refer to a level of unemployment below which inflation rises.

In 1985, Modigliani received MIT's James R. Killian Faculty Achievement Award. In 1997, he received an honoris causa degree in Management Engineering from the University of Naples Federico II in 1997.

In 1997, Modigliani and his granddaughter, Leah Modigliani, developed what is now called the "Modigliani Risk-Adjusted Performance," a measure of the risk-adjusted returns of an investment portfolio that was derived from the Sharpe ratio, adjusted for the risk of the portfolio relative to that of a benchmark, e.g. the "market."

Modigliani died in Cambridge, Massachusetts, in 2003, while still working at the MIT, and teaching until the last months of his life. Serena Modigliani-Calabi, active to the end in progressive politics, most notably with the League of Women Voters, and an outspoken believer in participatory democracy, died in 2008.

The same year, they all emigrated to the United States and he enrolled at the Graduate Faculty of the New School for Social Research. His doctoral thesis, an elaboration and extension of John Hicks’s IS–LM model, was written under the supervision of Jacob Marschak and Abba Lerner, in 1944, and is considered "ground breaking."