Keynes vs. Hayek: The Rise of the Chicago School of Economics
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The ideas of John Maynard Keynes and Friedrich von Hayek have dominated the economic landscape since the end of World War II. Both of these influential economists had distinct ideas about economic freedom--ideas that were very clearly in opposition to each other. The following link provides a two-minute video clip that explains the ideological differences between Keynes and Hayek (watch the first two minutes).
In this lesson, you will read about the different views of Keynes and Hayek on the role of government in the economy. You also will learn how their views influenced the "Chicago School of Thought," as well as our current economic system.
Following World War II, one major economic question dealt with the appropriate role for government in the economy. John Maynard Keynes, an English economist, developed theories that called for a large role for government in the economy. Daniel Yergin and Joseph Stanislaw (1998), explain Keynes' argument in this way: "The government would borrow money to spend on such things as public works; and that deficit spending, in turn, would create jobs and increase purchasing power. Striving to balance the government's budget during a slump would make things worse, not better. Keynes's analysis laid the basis for the field of macroeconomics, which treats the economy as a whole and focuses on government's use of fiscal policy--spending, deficits, and tax. These tools could be used to manage aggregate demand and thus ensure full employment. As a corollary, the government would cut back its spending during times of recovery and expansion." For more information about Keynes' ideas, read the two short paragraphs on Keynesian Economics
Keynes' views on economics were challenged by Friedrich von Hayek, who argued that "the problem was that under central planning, there was no economic calculation--no way to make a rational decision to put this resource here or buy that good there, because there was no price system to weigh the alternatives." Central planners could make technical decisions but not economic ones. Over the rest of the century, that criticism would prove to be extraordinarily prescient. "Socialism shocked our generation," Hayek later said. Yet, he added, it profoundly altered the outlook of idealists returning from the war. "I know, for I was one of them.... Socialism told us that we had been looking for improvement in the wrong direction"(Stanislaw and Yergin 1998).
To Hayek, less government intervention meant more economic freedom. He believed that when people are free to choose, the economy runs more efficiently. In the United States, the strongest supporters of Hayek's ideas were a group of economists at the University of Chicago. Known as the "Chicago School of Economics," this loosely formed, unofficial group of economists was generally associated with free market libertarianism. The name refers to economists who received their schooling in the Economics Department at the University of Chicago. To date, nearly half of all Nobel Prizes in Economics have been won by researchers with ties to Chicago.
Use the following link to the essay on the PBS "Commanding Heights " site. Click on "The Chicago School," read the essay, and answer the following questions.
According to Becker, what was the Chicago school's contribution to economic science?
How was the Chicago school in direct conflict with the Keynesian school of economic thought?
According to the Chicago economists, what should government’s role in the economy be?
According to Friedman, what produced the best results for economic freedom?
- In your own words, what is economic freedom?
The views of John Maynard Keynes and Fredrich von Hayek have been a driving force in the U.S. economy since the end of World War II. In the 1950s, 1960s and into the 1970s, Keynes' view of government as a key actor in the economy was the more popular theory. Since the 1970s, however, Hayek's view that government should only participate in the most limited way in our economy has gained popularity. The influence of Hayek's ideas and of the Chicago School, the chief supporter of the ideas, continues to be felt today. It is important to note, however, that Keynes and Hayek (and the Chicago School) represent the ends of the continuum, and that in practice, even the most market-oriented society (such as the United States) has a truly "mixed' economy," with the government playing a small but substantial role.
The Chicago School brought a strong belief in the system of free markets to our economy. This is in sharp contrast to the old ideas of using the government to help regulate the economy in economic bad times. This is not to say that Keynes was an advocate for central planning. He was an advocate for the use of government to help regulate the economy. Hayek, on the other hand, believed that economic freedom is tied to free markets, and the less government intervention, the better.
Using the information you have learned, answer the following questions.
Summarize the Chicago school of economic thought in your own words.
- In your own words, summarize Keynes' views on economics.
Follow the link to examine economic freedom from around the world. Pick three countries, each from different levels of economic freedom, and explain what makes them different in terms of levels of freedom. Additionally, what does the future hold for these countries? Do they have more economic freedom now than in the past, or vice versa?