Chicago school of economics

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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, Columbia University, Massachusetts Institute of Technology, and University of California, 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 economics was 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.[citation needed] Nonetheless, Kaufman (2010) says that the Chicago school can be generally characterized by the following:[1]

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.

As of 2018, the University of Chicago Economics department, considered one of the world's foremost economics departments, has been awarded 13 Nobel Prizes in Economics—more than any other university; and has also fielded more John Bates Clark medalists in economics than any other university.


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, 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 macroeconomists Robert 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 the Pareto efficiency, Chicago political economy came to the surprising and controversial view that politics tends towards efficiency and that policy advice is irrelevant.


Richard Thaler[edit]

Richard Thaler is a Nobel Prize-winner from 2017, is known for his work in behavioral economics.

James Heckman[edit]

James Heckman is a Nobel Prize-winner from 2000, is known for his pioneering work in econometrics and microeconomics.

Gary Becker[edit]

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 the founding fathers of Chicago political economy.[6]

Ronald Coase[edit]

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 mean that using corporations to produce things is more cost-effective.[7]

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. Only the existence of transaction costs may prevent this.[8]

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 people as 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[edit]

Nobel laureate Gene Fama is often called the "father of modern finance" for his contributions to the study of finance.

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 due to rational time-varying risk premia which can be modelled using the Fama–French three-factor model (1993, 1996) or their updated five-factor model (2014). 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 of the world.

Robert Fogel[edit]

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[edit]

The Nobel laureate Milton Friedman was affiliated with the University of Chicago for three decades; his ideas and his students made significant contributions to the development of Chicago School theory.

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.


— 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 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 fiscal (e.g. tax and spend) policy can have unintended negative effects. In Capitalism and Freedom (1992) Friedman wrote:[16]


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 calculator[s] of pleasure and pain", Friedman wrote:[17]

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[edit]

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[edit]

Nobel laureate Friedrich Hayek taught at the University of Chicago for over a decade; his ideas greatly influenced many Chicago economists.

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]

Frank Knight[edit]

Frank Knight (1885–1972) was an early member of the University of Chicago department. His most influential work was Risk, Uncertainty and Profit (1921) from which the term Knightian 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[edit]

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[edit]

Richard Posner ran a blog with Gary Becker.

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… [because] in a world of scarce resources waste should be regarded as immoral.

Theodore Schultz and D. Gale Johnson[edit]

A group of agricultural economists led by Ted 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.

George Stigler[edit]

George Stigler (1911–1991) was tutored for his thesis by Frank Knight and was awarded 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.


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 disciples seemed to be everywhere. If I stayed, it would be in an unfriendly environment."[27]

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 forgotten", 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 historically repressive and murderous Chilean military junta (and, to a lesser extent, other, similarly ultra-nationalist South American regimes) 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 dictator Augusto Pinochet; ninth highest of 12 South American countries) to $14,528 by the end of 2014 (the second 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] The percent of total income earned by the richest 20% of the Chilean population in 2006 was 56.8%, while the percent of total income earned by the poorest 20% of the Chilean population was 4.1%, leaving a strong middle class earning 39.1% of total income.[33] Chile's Gini index (measure of income distribution) was 52.0 in 2006, compared to 24.7 of Denmark (most equally distributed) and 74.3 of Namibia (most unequally distributed).[33] Chile has the widest inequality gap of any nation in the OECD.[34]

A film titled Chicago Boys, which had a highly critical view of the economic reforms, was released in Chile in November 2015.[35]

See also[edit]


  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. ^ a b Sturges v. Bridgman (1879) 11 Ch D 852
  8. ^ Coase (1960) IV, 7
  9. ^ Coase (1960) V, 9
  10. ^ Coase (1960) VIII, 23
  11. ^ [email protected] "Economist Rankings, Number of Citations - IDEAS/RePEc". 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. 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 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" (PDF). Journal of Economic Perspectives. Retrieved January 15, 2016.
  16. ^ Friedman (1992) p.
  17. ^ Friedman (1953) I,V,30
  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. 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.(Subscription or UK public library membership 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". 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 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
  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)
  27. ^ Paul H. Douglas, In the Fullness of Time, 1972, pp. 127–128.
  28. ^ Cassidy, John (4 January 2010). "After the Blowup". Retrieved 8 May 2018 – via www.newyorker.com.
  29. ^ Krugman, Paul (2009-09-06). "How Did Economists Get It So Wrong?". The New York Times. Retrieved 2010-04-28.
  30. ^ faculty.chicagobooth.edu/john.cochrane/research/papers/ecaf_2077.pdf
  31. ^ "World Development Indicators". World Bank. 12 January 2016. Retrieved 13 January 2016.
  32. ^ "The Boys Who Got to Remake an Economy". Slate. Retrieved 13 January 2016.
  33. ^ a b World Bank. (April 2010). Washington, DC: World Bank. Statistics retrieved 1 October 2010 from World Development Indicators database.
  34. ^ OECD says Chile has widest inequality gap. CBS News. March 18, 2014.
  35. ^ "Chicago Boys (2015)". IMDb. Retrieved 13 January 2016.

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