Chicago school of economics

The Chicago school of economics is a neoclassical 1 Terminology

school of economic thought associated with the work of
the faculty at the University of Chicago, some of whom The term was coined in the 1950s to refer to economists
have constructed and popularized its principles.
teaching in the Economics Department at the University
In the context of macroeconomics, it is connected to the of Chicago, and closely related academic areas at the Unifreshwater school of macroeconomics, in contrast to versity such as the Booth School of Business and the Law
the saltwater school based in coastal universities (notably School. They met together in frequent intense discussions
Harvard, MIT, and Berkeley). Chicago macroeconomic that helped set a group outlook on economic issues, based
theory rejected Keynesianism in favor of monetarism un- on price theory. The 1950s saw the height of popularity
til the mid-1970s, when it turned to new classical macroe- of the Keynesian school of economics, so the members
conomics heavily based on the concept of rational expec- of the University of Chicago were considered outside the
tations. The freshwater-saltwater distinction is largely an- mainstream.
tiquated today, as the two traditions have heavily incorpo- Besides what is popularly known as the Chicago school,
rated ideas from each other. Specically, New Keynesian there is also an Old Chicago school of economics, coneconomics was developed as a response to new classical sisting of an earlier generation of economists such as
economics, electing to incorporate the insight of rational Frank Knight, Henry Simons, Paul Douglas and othexpectations without giving up the traditional Keynesian ers. Nonetheless, these scholars had an important infocus on imperfect competition and sticky wages.
uence on the thought of Milton Friedman and George
Stigler, most notably in the development of price theory and transaction cost economics. However, their relationship to the modern macroeconomists (the third wave
of Chicago economics), led by Robert Lucas, Jr. and
Eugene Fama, is more blurred.

Chicago economists have also left their intellectual inuence in other elds, 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 aliated with Chicago have made
their impact in elds 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, Kaufman (2010) says that
the School can be generally characterized by:[1]

2 Scholars
2.1 Gary Becker
Main article: Gary Becker
Gary Becker (19302014) was a Nobel Prize-winner
from 1992 and was known in his work for applying economic methods of thinking to other elds, 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.

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.

2.2 Ronald Coase

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

Main articles: Ronald Coase and Law and economics

Ronald Coase (19102013) was the most prominent
economic analyst of law and the 1991 Nobel Prizewinner. His rst major article, "The Nature of the Firm"
(1937), argued that the reason for the existence of rms
1

(companies, partnerships, etc.) is the existence of transaction costs. Rational individuals trade through bilateral
contracts on open markets until the costs of transactions
mean that using corporations to produce things is more
cost-eective.[2]
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.[2] 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 benecial bargain that reaches the
same outcome of resource distribution. Only the existence of transaction costs may prevent this.[3]

SCHOLARS

rational forecasts of future earnings[7] and that the performance of actively managed funds is almost entirely due
to chance or exposure to risk[8] are all supportive of an
ecient-markets view of the world.

2.4 Robert Fogel

Main article: Robert Fogel

Robert Fogel (19262013), a co-winner of the Nobel

Prize in 1993, is well known for his historical analysis
and his introduction of New economic history,[9] and invention of cliometrics, a notation system for quantitative
data.[10] 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
So, the law ought to pre-empt what would happen, and be had a higher standard of living than the industrial proguided by the most ecient solution. The idea is that law letariat of the Northern states before the American civil
and regulation are not as important or eective at help- war.
ing people as lawyers and government planners believe.[4]
Coase and others like him wanted a change of approach,
to put the burden of proof for positive eects on a gov- 2.5 Milton Friedman
ernment that was intervening in the market, by analysing
the costs of action.[5]
Main articles: Milton Friedman and Monetarism

2.3

Eugene Fama

Main articles: Eugene Fama and Ecient-market hypothesis

Eugene Fama (born 1939) is an American nancial
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.[6] He has spent all of his teaching career at the University of Chicago and is the originator of the ecientmarket hypothesis, rst dened 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, Ecient
Capital Markets: A Review of Theory and Empirical
Work, which brought the notion of ecient markets into
the forefront of modern economic theory, and his 1991
article, Ecient 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 due
to rational time-varying risk premia which can be modelled using the FamaFrench three-factor model (1993,
1996) or their updated ve-factor model (2014). His
work showing that the value premium can persist despite

Milton Friedman (19122006) stands as one of the most

inuential economists of the late twentieth century. A
student of Frank Knight, he won 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
Hener on The Open Mind (7 December
1975)

Governments should aim for a neutral monetary policy oriented toward long-run economic growth, by gradual expansion of the money supply. He advocated the
quantity theory of money, that general prices are determined by money. Therefore, active monetary (e.g. easy
credit) or scal (e.g. tax and spend) policy can have unintended negative eects. In Capitalism and Freedom
(1967) Friedman wrote:[11]

2.9

Richard Posner

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.

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. Lucass works
cover several topics in macroeconomics, included ecoThe slogan that money matters has come to be as- nomic growth, asset pricing, and monetary Economics.
sociated with Friedman, but Friedman had also leveled
harsh criticism of his ideological opponents. Referring
2.9 Richard Posner
to Thorstein Veblen's assertion that economics unrealistically models people as lightning calculator[s] of pleasure
Main article: Richard Posner
and pain, Friedman wrote:[12]
Richard Posner (born 1939) is known primarily for
Criticism of this type is largely beside the
point unless supplemented by evidence that a
hypothesis diering in one or another of these
respects from the theory being criticized yields
better predictions for as wide a range of phenomena.

2.6

Lars Peter Hansen

Main article: 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 macroe- Richard Posner ran a blog with Gary Becker.
conomist, focusing on the linkages between the nancial
his work in law and economics, though Robert Solow
and real sectors of the economy.
describes Posners grasp of certain economic ideas as
in some respects,... precarious.[13] A federal appellate judge rather than an economist, Posners main work,
2.7 Frank Knight
Economic Analysis of Law attempts to apply rational
choice models to areas of law. He has chapters on tort,
Main article: Frank Knight
contract, corporations, labor law, but also criminal law,
discrimination and family law. Posner goes so far as to
Frank Knight (18851972) was an early member of the say that:[14]
University of Chicago department. His most inuential
work was Risk, Uncertainty and Prot (1921) from which
[the central] meaning of justice, perhaps
the term Knightian uncertainty was coined. Knights perthe most common is eciency [because]
spective was iconoclastic, and markedly dierent from
in a world of scarce resources waste should be
later Chicago school thinkers. He believed that while the
regarded as immoral.
free market could be inecient, government programs
were even less ecient. He drew from other economic
schools of thought such as institutional economics to form 2.10 Theodore Schultz and D. Gale Johnhis own nuanced perspective.
son

2.8

Robert E. Lucas

Main article: Robert Lucas, Jr.

Main articles: Theodore Schultz and D. Gale Johnson

A group of agricultural economists led by Ted Schultz and
D. Gale Johnson moved from Iowa State to the Univer-

4
sity 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 presedent of the American Economics Association
in 1999. Their research in farm and agricultural economics was widely inuential and attracted funding from
the Rockefeller Foundation to the agricultural economics
program at the University. Among the graduate students
and faculty aliated with the pair in the 1940s and 1950s
were Cliord Hardin, Zvi Griliches, Marc Nerlove, and
George S. Tolley.[15] In 1979, Schultzs was awarded the
Nobel Prize in Economics for his work in human capital
theory and economic development.

4 SEE ALSO
is consistent with the large decline in asset prices since
the event was unpredictable.[19] Specically, 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 don't 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 hardwon knowledge has been forgotten, claiming that most
peer-reviewed macroeconomic research since the mid1960s has been wrong, preferring models developed in
the 1930s.[20] Chicago nance economist John Cochrane
2.11 George Stigler
countered that these criticisms were ad hominem, displayed a deep and highly politicized ignorance of what
Main article: George Stigler
economics and nance is really all about, and failed to
disentangle bubbles from rational risk premiums and cryGeorge Stigler (19111991) was tutored for his thesis by ing wolf too many times in a row, emphasizing that even
Frank Knight and won the Nobel Prize in Economics in if these criticisms were true, it would make a stronger ar1982. He is best known for developing the Economic The- gument against regulation and control.[21]
ory of Regulation,[16] also known as regulatory capture,
Finally, the school also has been criticized for training
which says that interest groups and other political particeconomists who advised the Chilean government (and
ipants will use the regulatory and coercive powers of govto a lesser extent other South American governments)
ernment to shape laws and regulations in a way that is benduring the 1970s and 1980s. Whilst they were credecial to them. This theory is an important component of
ited with transforming Chile into Latin Americas best
the Public Choice eld of economics. He also carried out
performing economy,[22] with GDP per capita increasextensive research into the history of economic thought.
ing from US$693 at the start of 1975 (the year Milton
His 1962 article Information in the Labor Market[17]
Friedman met with Augusto Pinochet; 9th highest of 12
developed the theory of search unemployment.
South American countries) to $14,528 by the end of 2014
(the 2nd highest in South America),[23] critics counter
there was a corresponding increase in income inequality
3 Criticisms
and that the reforms had a negative inuence on the economic policies of Ronald Reagan and Margaret Thatcher.
Paul Douglas, economist and Democratic senator from In the years since the reforms were introduced, the ecoIllinois for 18 years, was uncomfortable with the envi- nomic system implemented by the 'Chicago Boys' (a label
group of economists) have mostly remained
ronment he found at the university. He stated that, . . given to this
[24]
in
place.
A
lm titled Chicago Boys was released in
. I was disconcerted to nd that the economic and poChile
in
November
2015, which had a highly critical view
litical conservatives had acquired almost complete dom[25]
of
the
economic
reforms.
inance over my department and taught that market decisions were always right and prot values the supreme
ones . . . The opinions of my colleagues would have
conned government to the eighteenth-century functions
4 See also
of justice, police, and arms, which I thought had been
insucient even for that time and were certainly so for
ours. These men would neither use statistical data to de Chicago Boys
velop economic theory nor accept critical analysis of the
economic system . . . (Frank) Knight was now openly
hostile, and his disciples seemed to be everywhere. If I General:
stayed, it would be in an unfriendly environment.[18]
Whilst the ecacy of Eugene Famas ecient-market
hypothesis (EMH) was debated after the nancial crisis of 200708, proponents emphasized that the EMH

History of economic thought

Perspectives on Capitalism

References

[1] Bruce Kaufman in Ross B. Emmett, ed. The Elgar Companion to the Chicago School of Economics (2010) p. 133
[2] Sturges v. Bridgman (1879) 11 Ch D 852
[3] Coase (1960) IV, 7

[23] World Development Indicators. World Bank. 12 January 2016. Retrieved 13 January 2016.
[24] The Boys Who Got to Remake an Economy. Slate. Retrieved 13 January 2016.
[25] Chicago Boys (2015)". IMDb. Retrieved 13 January
2016.

[4] Coase (1960) V, 9

[5] Coase (1960) VIII, 23
[6] https://ideas.repec.org/top/top.person.nbcites.html
[7] Fama and French (1995)
[8] Fama and French (2012)
[9] Fogel, Robert (December 1966). The New Economic
History. Its Findings and Methods. The Economic History Review. 19 (3): 642656. doi:10.1111/j.14680289.1966.tb00994.x. JSTOR 2593168. The 'new economic history', sometimes called economic history or
cliometrics, is not often practiced in Europe. However,
it is fair to say that eorts to apply statistical and mathematical models currently occupy the centre of the stage in
American economic history.
[10] Golden, Claudia (1995). Cliometrics and the Nobel
(PDF). Journal of Economics Perspective. Retrieved January 15, 2016.
[11] Friedman (1967) p.
[12] Friedman (1953) I,V,30
[13] Solow, Robert M. (2009). How to Understand the Disaster. The New York Review of Books. 56 (8). Retrieved
31 August 2012.
[14] Richard Posner, Economic Analysis of Law (1998) p. 30
[15] Sumner, Daniel A. Agricultural Economics at Chicago, 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
[16] The Theory of Economic Regulation. (1971) Bell Journal of Economics and Management Science, no. 3, pp.
318.
[17] See also, The Economics of Information, (1961) Journal of Political Economy, June. (JSTOR)

6 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.
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, 19451957. London: Routledge.
ISBN 0-415-70078-7.
Hovenkamp, Herbert (1985). Antitrust Policy after Chicago. Michigan Law Review. Michigan
Law Review, Vol. 84, No. 2. 84 (2): 213284.
doi:10.2307/1289065. JSTOR 1289065.
Kasper, Sherryl (2002). The Revival of LaissezFaire 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): 6469. 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 0271-02095-4.

[19] http://www.newyorker.com/reporting/2010/01/11/
100111fa_fact_cassidy

Reder, Melvin W. (1982). Chicago Economics:

Permanence and Change. Journal of Economic Literature. 20 (1): 138. Reprinted in John Cunningham Wood & R.N. Woods (1990), Milton Friedman:
Critical Assessments, pp. 343393.

[20] Krugman, Paul (2009-09-06). How Did Economists Get

It So Wrong?". The New York Times. Retrieved 2010-0428.

Stigler, George J. (1988). Chicago Studies in Political Economy. Chicago: University of Chicago
Press. ISBN 0-226-77437-6.

[21] faculty.chicagobooth.edu/john.cochrane/research/
papers/ecaf_2077.pdf

Stigler, George J. (1988). Memoirs of an Unregulated Economist. New York: Basic Books. ISBN
0-465-04443-3. Description & preview.

[18] Paul H. Douglas, In the Fulness of Time, 1972, p. 127128

[22] Miracle of Chile

7
Valdes, Juan Gabriel (2008): Pinochets 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 Twentieth 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

EXTERNAL LINKS

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