Chicago school of economics

The Chicago school of economics is a neoclassical school of economic thought associated with the work of the faculty at the
University of Chicago, some of whom have constructed and popularized its principles.

In the context of macroeconomics, it is connected to the "freshwater school" of macroeconomics, in contrast to the saltwater school
based in coastal universities (notably Harvard University, MIT, and UC Berkeley). Chicago macroeconomic theory rejected
Keynesianism in favor of monetarism until the mid-1970s, when it turned to new classical macroeconomics heavily based on the
concept of rational expectations. The freshwater-saltwater distinction is largely antiquated today, as the two traditions have heavily
incorporated ideas from each other. Specifically, New Keynesian economicswas developed as a response to new classical economics,
electing to incorporate the insight of rational expectations without giving up the traditional Keynesian focus on imperfect competition
and sticky wages.

Chicago economists have also left their intellectual influence in other fields, notably in pioneering public choice theory and law and
economics, which have led to revolutionary changes in the study of political science and law. Other economists affiliated with
Chicago have made their impact in fields as diverse as social economics and economic history. Thus, there is not a clear delineation
of the Chicago school of economics, a term that is more commonly used in the popular media than in academic circles. Nonetheless,
[1]
Kaufman (2010) says that the School can be generally characterized by:

A deep commitment to rigorous scholarship and open academic debate, an uncompromising belief in the usefulness
and insight of neoclassical price theory, and a normative position that favors and promotes economic liberalism and
free markets.

The University of Chicago Economics department, considered one of the world's foremost economics departments, has fielded 12
Nobel Prizes laureates in economics—more than any other university (as of January 2016, MIT is second at 6); and has also fielded
more John Bates Clark medalistsin economics than any other university.

Contents
Terminology
Scholars
Gary Becker
Ronald Coase
Eugene Fama
Robert Fogel
Milton Friedman
Lars Peter Hansen
Friedrich Hayek
Frank Knight
Robert E. Lucas
Richard Posner
Theodore Schultz and D. Gale Johnson
George Stigler
Criticisms
See also
References
Further reading
 External links

Terminology
The term was coined in the 1950s to refer to economists teaching in the Economics Department at the University of Chicago, and
closely related academic areas at the University such as the Booth School of Business and the Law School. They met together in
frequent intense discussions that helped set a group outlook on economic issues, based on price theory. The 1950s saw the height of
popularity of the Keynesian school of economics, so the members of the University of Chicago were considered outside the
mainstream.

Besides what is popularly known as the "Chicago school", there is also an "Old Chicago" school of economics, consisting of an
earlier generation of economists such as Frank Knight, Henry Simons, Lloyd Mints, Paul Douglas, Jacob Viner, Aaron Director and
others.[2] This group had diverse interests and approaches, but Knight, Simons, and Director in particular advocated a focus on the
role of incentives and the complexity of economic events rather than on general equilibrium. Outside of Chicago, these early leaders
were important influences on the Virginia school of political economy.[3] Nonetheless, these scholars had an important influence on
the thought of Milton Friedman and George Stigler, most notably in the development of price theory and transaction cost
economics.[4] A third wave of Chicago economics is led by macroeconomistsRobert Lucas, Jr. and Eugene Fama.[5]

A further significant branching of Chicago thought was dubbed by George Stigler as "Chicago political economy". Inspired by the
Coasian view that institutions evolve to maximize Pareto-efficiency, Chicago political economy came to the surprising and
controversial view that politics tends towards efficiency and that policy advice is irrelevant.

Scholars

Gary Becker
Gary Becker (1930–2014) was a Nobel Prize-winner from 1992 and was known in his work for applying economic methods of
thinking to other fields, such as crime, sexual relationships, slavery and drugs, assuming that people act rationally. His work was
originally focused in labor economics. His work partly inspired the popular economics book Freakonomics. He is considered one of
.[6]
the founding fathers of Chicago political economy

Ronald Coase
Ronald Coase (1910–2013) was the most prominent economic analyst of law and the 1991 Nobel Prize-winner. His first major
article, "The Nature of the Firm" (1937), argued that the reason for the existence of firms (companies, partnerships, etc.) is the
existence of transaction costs. Rational individuals trade through bilateral contracts on open markets until the costs of transactions
fective.[7]
mean that using corporations to produce things is more cost-ef

His second major article, "The Problem of Social Cost" (1960), argued that if we lived in a world without transaction costs, people
would bargain with one another to create the same allocation of resources, regardless of the way a court might rule in property
disputes. Coase used the example of an 1879 London legal case about nuisance named Sturges v Bridgman, in which a noisy
sweetmaker and a quiet doctor were neighbours; the doctor went to court seeking an injunction against the noise produced by the
sweetmaker.[7] Coase said that regardless of whether the judge ruled that the sweetmaker had to stop using his machinery, or that the
doctor had to put up with it, they could strike a mutually beneficial bargain that reaches the same outcome of resource distribution.
[8]
Only the existence of transaction costs may prevent this.

So, the law ought to pre-empt what would happen, and be guided by the most efficient solution. The idea is that law and regulation
are not as important or effective at helping peopleas lawyers and government planners believe.[9] Coase and others like him wanted a
change of approach, to put the burden of proof for positive effects on a government that was intervening in the market, by analysing
the costs of action.[10]
Eugene Fama
Eugene Fama (born 1939) is an American financial economist who was awarded the
Nobel Prize in Economics in 2013 for his work on empirical asset pricing and is the
seventh most highly cited economist of all time.[11] He has spent all of his teaching
career at the University of Chicago and is the originator of the efficient-market
hypothesis, first defined in his 1965 article as market where "at any point in time, the
actual price of a security will be a good estimate of its intrinsic value". The notion
was further explored in his 1970 article, "Efficient Capital Markets: A Review of
Theory and Empirical Work", which brought the notion of efficient markets into the
forefront of modern economic theory, and his 1991 article, "Efficient Markets II".
Whilst his 1965 Ph.D. thesis, "The Behavior of Stock Market Prices", showed that
stock prices can be approximated by a random walk in the short-term; in later work
he showed that insofar as stock prices are predictable in the long-term, it is largely Nobel laureate Gene Fama is often
due to rational time-varying risk premia which can be modelled using the Fama– called the "father of modern finance"
for his contributions to the study of
French three-factor model (1993, 1996) or their updated five-factor model (2014).
finance.
His work showing that the value premium can persist despite rational forecasts of
future earnings[12] and that the performance of actively managed funds is almost
entirely due to chance or exposure to risk[13] are all supportive of an efficient-markets view ofthe world.

Robert Fogel
Robert Fogel (1926–2013), a co-winner of the Nobel Prize in 1993, is well known for his historical analysis and his introduction of
New economic history,[14] and invention of cliometrics.[15] In his tract, Railroads and American Economic Growth: Essays in
Econometric History, Fogel set out to rebut comprehensively the idea that railroads contributed to economic growth in the 19th
century. Later, in Time on the Cross: The Economics of American Negro Slavery, he argued that slaves in the Southern states of
America had a higher standard of living than the industrial proletariat of the Northern states before the
American civil war.

Milton Friedman
Milton Friedman (1912–2006) stands as one of the most influential economists of
the late twentieth century. A student of Frank Knight, he was awarded the Nobel
Prize in Economics in 1976 for, among other things, A Monetary History of the
United States (1963). Friedman argued that the Great Depression had been caused
by the Federal Reserve's policies through the 1920s, and worsened in the 1930s.
Friedman argued that laissez-faire government policy is more desirable than
government intervention in the economy.

One of the great mistakes is to judge policies and programs by their

intentions rather than their results.

— Milton Friedman Interview with Richard Heffner

on The Open Mind (7 December 1975)

Governments should aim for a neutral monetary policy oriented toward long-run The Nobel laureate Milton Friedman
was affiliated with the University of
economic growth, by gradual expansion of the money supply. He advocated the
Chicago for three decades; his ideas
quantity theory of money, that general prices are determined by money. Therefore,
and his students made significant
active monetary (e.g. easy credit) or fiscal (e.g. tax and spend) policy can have contributions to the development of
unintended negative effects. In Capitalism and Freedom (1992) Friedman wrote:[16] Chicago School theory.
 There is likely to be a lag between the need for action and
government recognition of the need; a further lag between
recognition of the need for action and the taking of action; and a still
further lag between the action and its effects.

The slogan that "money matters" has come to be associated with Friedman, but Friedman had also leveled harsh criticism of his
ideological opponents. Referring to Thorstein Veblen's assertion that economics unrealistically models people as "lightning
[17]
calculator[s] of pleasure and pain", Friedman wrote:

Criticism of this type is largely beside the point unless supplemented by evidence that a hypothesis differing in one or
another of these respects from the theory being criticized yields better predictions for as wide a range of phenomena.

Lars Peter Hansen

Lars Peter Hansen (born 1952) is an American economist who won the Nobel Prize in Economics in 2013 with Eugene Fama and
Robert Shiller for their work on asset pricing. Hansen began teaching at the University of Chicago in 1981 and is the David
Rockefeller Distinguished Service Professor of economics at the University of Chicago. Although best known for his work on the
Generalized Method of Moments, he is also a distinguished macroeconomist, focusing on the linkages between the financial and real
sectors of the economy.

Friedrich Hayek
Friedrich Hayek (1899-1992) Hayek made contact with many at the University of Chicago in
the 1940s, with Hayek's The Road to Serfdom playing a seminal role in transforming how
Milton Friedman and others understood how society works.[18] Hayek conducted a number of
influential faculty seminars while at the U. of Chicago, and a number of academics worked on
research projects sympathetic to some of Hayek's own, such as Aaron Director, who was
active in the Chicago School in helping to fund and establish what became the "Law and
Society" program in the University of Chicago Law School.[19] Hayek, Frank Knight,
Friedman and George Stigler worked together in forming the Mont Pèlerin Society, an
international forum for libertarian economists. Hayek and Friedman cooperated in support of
the Intercollegiate Society of Individualists, later renamed the Intercollegiate Studies Institute,
an American student organisation devoted to libertarian ideas.[20] [21]
Nobel laureate Friedrich
Hayek taught at the
Frank Knight University of Chicago for
over a decade; his ideas
Frank Knight (1885–1972) was an early member of the University of Chicago department. His
greatly influenced many
most influential work was Risk, Uncertainty and Profit (1921) from which the term Knightian Chicago economists.
uncertainty was derived. Knight's perspective was iconoclastic, and markedly different from
later Chicago school thinkers. He believed that while the free market could be inefficient,
government programs were even less efficient. He drew from other economic schools of thought such as institutional economics to
form his own nuanced perspective.

Robert E. Lucas
Robert Lucas (born 1937), who won the Nobel Prize in 1995, has dedicated his life to unwinding Keynesianism. His major
contribution is the argument that macroeconomics should not be seen as a separate mode of thought from microeconomics, and that
analysis in both should be built on the same foundations. Lucas's works cover several topics in macroeconomics, included economic
growth, asset pricing, and monetary Economics.
Richard Posner
Richard Posner (born 1939) is known primarily for his work in law and economics, though Robert
Solow describes Posner's grasp of certain economic ideas as "in some respects,... precarious".[22]
A federal appellate judge rather than an economist, Posner's main work, Economic Analysis of
Law attempts to apply rational choice models to areas of law. He has chapters on tort, contract,
corporations, labor law, but also criminal law, discrimination and family law. Posner goes so far
as to say that:[23]

[the central] meaning of justice, perhaps the most common is – efficiency…

Richard Posner ran a
[because] in a world of scarce resources waste should be regarded as immoral.
blog with Gary Becker.

Theodore Schultz and D. Gale Johnson

A group of agricultural economists led by T
ed Schultz and D. Gale Johnson moved from
Iowa State to the University of Chicago in the mid-1940s. Schultz served as the chair of
economics from 1946 to 1961. He became president of the American Economic
Association in 1960, retired in 1967, though he remained active at the University of
Chicago until his death in 1998. Johnson served as department chair from 1971-1975
and 1980-1984 and was president of the American Economics Association in 1999.
Their research in farm and agricultural economics was widely influential and attracted
funding from the Rockefeller Foundation to the agricultural economics program at the
University. Among the graduate students and faculty affiliated with the pair in the 1940s
and 1950s were Clifford Hardin, Zvi Griliches, Marc Nerlove, and George S. Tolley.[24]
In 1979, Schultz's was awarded the Nobel Prize in Economics for his work in human
capital theory and economic development.

Schultz receiving Nobel Prize

George Stigler
from King of Sweden Carl XVI
George Stigler (1911–1991) was tutored for his thesis byFrank Knight and was awarded Gustaf in 1979.
the Nobel Prize in Economics in 1982. He is best known for developing the Economic
Theory of Regulation,[25] also known as regulatory capture, which says that interest
groups and other political participants will use the regulatory and coercive powers of government to shape laws and regulations in a
way that is beneficial to them. This theory is an important component of the Public Choice field of economics. He also carried out
extensive research into the history of economic thought. His 1962 article "Information in the Labor Market"[26] developed the theory
of search unemployment.

Criticisms
Paul Douglas, economist and Democratic senator from Illinois for 18 years, was uncomfortable with the environment he found at the
university. He stated that, "…I was disconcerted to find that the economic and political conservatives had acquired almost complete
dominance over my department and taught that market decisions were always right and profit values the supreme ones… The
opinions of my colleagues would have confined government to the eighteenth-century functions of justice, police, and arms, which I
thought had been insufficient even for that time and were certainly so for ours. These men would neither use statistical data to
develop economic theory nor accept critical analysis of the economic system… (Frank) Knight was now openly hostile, and his
[27]
disciples seemed to be everywhere. If I stayed, it would be in an unfriendly environment."

While the efficacy of Eugene Fama's efficient-market hypothesis (EMH) was debated after the financial crisis of 2007–08,
proponents emphasized that the EMH is consistent with the large decline in asset prices since the event was unpredictable.[28]
Specifically, if market crashes never occurred, this would contradict the EMH since the average return of risky assets would be too
large to justify the decreased risk of a large decline in prices; and if anything, the equity premium puzzle implies that market crashes
do not happen enough to justify the high Sharpe ratio of US stocks and other risky assets.

Economist Brad DeLong of the University of California, Berkeley says the Chicago School has experienced an "intellectual
collapse", while Nobel laureate Paul Krugman of Princeton University says that some recent comments from Chicago school
economists are "the product of a Dark Age of macroeconomics in which hard-won knowledge has been for
gotten", claiming that most
peer-reviewed macroeconomic research since the mid-1960s has been wrong, preferring models developed in the 1930s.[29] Chicago
finance economist John Cochrane countered that these criticisms were ad hominem, displayed a "deep and highly politicized
ignorance of what economics and finance is really all about", and failed to disentangle bubbles from rational risk premiums and
crying wolf too many times in a row, emphasizing that even if these criticisms were true, it would make a stronger argument against
regulation and control.[30]

Finally, the school also has been criticized for training economists who advised the Chilean government (and to a lesser extent other
South American governments) during the 1970s and 1980s. While they were credited with transforming Chile into Latin America's
best performing economy (see Miracle of Chile) with GDP per capita increasing from US$693 at the start of 1975 (the year Milton
Friedman met with Augusto Pinochet; 9th highest of 12 South American countries) to $14,528 by the end of 2014 (the 2nd highest in
South America),[31] critics counter there was a corresponding increase in income inequality and that the reforms had a negative
influence on the economic policies of Ronald Reagan and Margaret Thatcher. In the years since the reforms were introduced, the
economic system implemented by the "Chicago Boys" (a label given to this group of economists) have mostly remained in place.[32]
[33]
A film titled Chicago Boys, which had a highly critical view of the economic reforms, was released in Chile in November 2015.

See also
History of economic thought
Market monetarism
Perspectives on capitalism by school of thought

References
1. Bruce Kaufman in Ross B. Emmett, ed.The Elgar Companion to the Chicago School of Economics(2010) p. 133
2. Shils 1991, p538; Emmett 2001, p235
3. Emmett 2001, p235
4. Emmett 2010 p7; Emmett 2009, p147
5. Shils 1991 p538
6. Palda, Filip. A Better Kind of Violence: Chicago Political Economy, Public Choice, and the Quest for an Ultimately
Theory of Power. Cooper-Wolfling Press. 2016.
7. Sturges v. Bridgman (1879) 11 Ch D 852
8. Coase (1960) IV, 7
9. Coase (1960) V, 9
10. Coase (1960) VIII, 23
11. zimmermann@stlouisfed.org."Economist Rankings, Number of Citations - IDEAS/RePEc"(https://ideas.repec.org/to
p/top.person.nbcites.html). ideas.repec.org. Retrieved 8 May 2018.
12. Fama and French (1995)
13. Fama and French (2012)
14. Fogel, Robert (December 1966). "The New Economic History . Its Findings and Methods".The Economic History
Review. 19 (3): 642–656. doi:10.1111/j.1468-0289.1966.tb00994.x(https://doi.org/10.1111/j.1468-0289.1966.tb0099
4.x). JSTOR 2593168 (https://www.jstor.org/stable/2593168). "The 'new economic history', sometimes called
economic history or cliometrics, is not often practiced in Europe. However , it is fair to say that efforts to apply
statistical and mathematical models currently occupy the centre of the stage in American economic history ."
15. Golden, Claudia (1995)."Cliometrics and the Nobel"(http://scholar.harvard.edu/files/goldin/files/cliometrics.pdf)
(PDF). Journal of Economic Perspectives. Retrieved January 15, 2016.
16. Friedman (1992) p.
17. Friedman (1953) I,V,30 (http://members.shaw.ca/compilerpress1/Anno%20Friedman%20Positive%20c.htm)
18. Milton and Rose Friedman,Two Lucky People: Memoirs(Chicago: U. of Chicago Press, 1998)
19. Ross B. Emmett (2010).The Elgar Companion to the Chicago School of Economics(https://books.google.com/book
s?id=MaCciKWcDIAC&pg=PA266). Edward Elgar Publishing. pp. 164, 200, 266–67.ISBN 9781849806664.
20. Brittan, Samuel (2004). "Hayek, Friedrich August (1899–1992)".Oxford Dictionary of National Biography(online ed.).
Oxford University Press.doi:10.1093/ref:odnb/51095(https://doi.org/10.1093/ref%3Aodnb/51095). (Subscription or UK
public library membership (http://www.oxforddnb.com/help/subscribe#public) required.)
21. Johan Van Overtveldt, The Chicago School: How the University of Chicago Assembled the Thinkers Who
Revolutionized Economics and Business(2006) pp. 7, 341–46
22. Solow, Robert M. (2009). "How to Understand the Disaster"(http://www.nybooks.com/articles/archives/2009/may/14/
how-to-understand-the-disaster/). The New York Review of Books. 56 (8). Retrieved 31 August 2012.
23. Richard Posner, Economic Analysis of Law(1998) p. 30
24. Sumner, Daniel A. Agricultural Economics atChicago, in David Gale Johnson, John M. Antle. The Economics of
Agriculture: Papers in honor of D. Gale Johnson. University of Chicago Press, 1996 p 14-29
25. "The Theory of Economic Regulation." (1971) Bell Journal of Economics and Management Science, no. 3, pp. 3–18.
26. See also, "The Economics of Information," (1961)Journal of Political Economy, June. (JSTOR) (https://www.jstor.or
g/stable/1829263)
27. Paul H. Douglas, In the Fullness of Time, 1972, pp. 127–128.
28. Cassidy, John (4 January 2010)."After the Blowup" (https://www.newyorker.com/magazine/2010/01/11/after-the-blo
wup). Retrieved 8 May 2018 – via www.newyorker.com.
29. Krugman, Paul (2009-09-06)."How Did Economists Get It So Wrong?" (https://www.nytimes.com/2009/09/06/magazi
ne/06Economic-t.html). The New York Times. Retrieved 2010-04-28.
30. faculty.chicagobooth.edu/john.cochrane/research/papers/ecaf_2077.pdf
31. "World Development Indicators"(http://www.google.com.au/publicdata/explore?ds=d5bncppjof8f9_&met_y=ny_gdp_
pcap_cd&idim=country:CHL:ARG:PER&hl=en&dl=en#!ctype=l&strail=false&bcs=d&nselm=h&met_y=ny_gdp_pcap_
cd&scale_y=lin&ind_y=false&rdim=region&idim=country:CHL:ARG:PER:BRA:COL:VEN:ECU:BOL:UR Y:PRY:GUY:S
UR&ifdim=region&tstart=158763600000&tend=1389531600000&hl=en_US&dl=en&ind=false) . World Bank. 12
January 2016. Retrieved 13 January 2016.
32. "The Boys Who Got to Remake an Economy"(http://www.slate.com/articles/business/moneybox/2016/01/in_chicago
_boys_the_story_of_chilean_economists_who_studied_in_america_and.html) . Slate. Retrieved 13 January 2016.
33. "Chicago Boys (2015)"(https://www.imdb.com/title/tt4123562/). IMDb. Retrieved 13 January 2016.

Further reading
Emmett, Ross B., ed. The Elgar Companion to the Chicago School of Economics(Edward Elgar, 2010), 350 pp.;
ISBN 978-1-84064-874-4
Emmett, Ross B. (2008). "Chicago School (new perspectives)",The New Palgrave Dictionary of Economics, 2nd
Edition. Abstract.
Emmett, Ross B. (2009). Frank Knight and the Chicago school in American economics. Routledge
Friedman, Milton; Friedman, Rose (1998).Two Lucky People: Memoirs. Chicago: University of Chicago Press.
ISBN 0-226-26414-9.
Hammond, J. Daniel; Hammond, Claire H. (2006).Making Chicago Price Theory: Friedman-Stigler Correspondence,
1945–1957. London: Routledge. ISBN 0-415-70078-7.
Hamowy, Ronald (2008). "Economics, Chicago School of". In Hamowy, Ronald. The Encyclopedia of Libertarianism.
Thousand Oaks, CA: SAGE; Cato Institute. pp. 135–37. doi:10.4135/9781412965811.n85. ISBN 978-1412965804.
LCCN 2008009151. OCLC 750831024.
Hovenkamp, Herbert (1985). "Antitrust Policy after Chicago".Michigan Law Review. Michigan Law Review, Vol. 84,
No. 2. 84 (2): 213–284. doi:10.2307/1289065. JSTOR 1289065.
Kasper, Sherryl (2002). The Revival of Laissez-Faire in American Macroeconomic Theory: A Case Study of Its
Pioneers. Cheltenham: Edward Elgar. ISBN 1-84064-606-3.
Miller, H. Laurence, Jr. (1962). "On the 'Chicago School of Economics
' ". The Journal of Political Economy. 70 (1):
64–69. doi:10.1086/258588.
 Nelson, Robert H. (2001).Economics As Religion: From Samuelson to Chicago and Beyond . University Park, PA:
Pennsylvania State Univ. Press. ISBN 0-271-02095-4.
Palda, Filip (2016). A Better Kind of Violence: Chicago Political Economy, Public Choice, and the Quest for an
Ultimate Theory of Power. Kingston, ON: Cooper Wolfling Press. ISBN 978-0-9877880-7-8.
Reder, Melvin W. (1982). "Chicago Economics: Permanence and Change".Journal of Economic Literature. 20 (1):
1–38. Reprinted in John Cunningham Wood & R.N. Woods (1990), Milton Friedman: Critical Assessments, pp. 343–
393.
Shils, Edward, ed. (1991). Remembering the University of Chicago: teachers, scientists, and scholars. University of
Chicago Press.
Stigler, George J. (1988). Chicago Studies in Political Economy. Chicago: University of Chicago Press.ISBN 0-226-
77437-6.
Stigler, George J. (1988). Memoirs of an Unregulated Economist. New York: Basic Books. ISBN 0-465-04443-3.
Description & preview.
Valdes, Juan Gabriel (2008).Pinochet's Economists: The Chicago School of Economics in Chile (Historical
Perspectives on Modern Economics). Cambridge University Press. ISBN 0-521-06440-6.
Wahid, Abu N. M. (2002).Frontiers of Economics: Nobel Laureates of the w T entieth Century. Westport, CT:
Greenwood Press. ISBN 0-313-32073-X.

External links
Thomas Sowell
The University of Chicago Department of Economics
Commanding Heights, PBS Documentary , Chicago Against the Tide

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