Keynes vs. Hayek: The Rise of the Chicago School of Economics

Key Economic Concepts:

• Economic Freedom
• Market Economy
• Role of Government

Description:

Economic freedom is freedom from government intervention in the production and distribution of goods and services. After World War II, governments were trying to rebuild their economies from the ground up. They looked to the ideas of the top economists of their day for guidance. These ideas have shaped economic systems and the idea of economic freedom for many years.

Lesson Objectives:

Students will:

• Learn about differences between Keynes' and Hayek's economic philosophies.
• Describe economic freedom according to Hayek and the Chicago School of Thought, and as current economists describe it.
• Explain how Keynes' economic policies could limit economic freedom.

Introduction:

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. Click on www.pbs.org/wgbh/commandingheights; then choose the "Battle of Ideas, The Core Debate" clip (choose the media player your computer is equipped with).

In this lesson, the students will read about the different views of Keynes and Hayek on the role of government in the economy. They also will learn how their views influenced the famed “Chicago School of thought,” as well as our current economic system.

Resources:

"The Chicago School" From the PBS 'Commanding Heights' site. www.pbs.org/wgbh/commandingheights/lo/ideas/essay.html

"The Chicago School," in PDF format: www.pbs.org/wgbh/commandingheights/shared/pdf/ess_chicagoschool.pdf

"The Battle of Ideas: The Core Debate- Markets vs Government"-Video Clip: www.pbs.org/wgbh/commandingheights/shared/minitextlo/vid_friedrichvonhayek.html

"Keynesian School" www.frbsf.org/publications/education/greateconomists/grtschls.html#A8

"2005 Index of Economic Freedom" www.heritage.org/research/features/index/countries.cfm

Process:

http://www.econedlink.org/lessons/images_lessons/593_Keynes1.gifFollowing 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, have the students read the short article about Keynesian Economics from the following site: www.frbsf.org/publications/education/greateconomists/grtschls.html#A8.

Keynes' views on economics were challenged by Friedrich von Hayek who argued that "The problem was that under http://www.econedlink.org/lessons/images_lessons/593_vonhayek1.gifcentral 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.

www.pbs.org/wgbh/commandingheights/lo/ideas/essay.html. Click on "The Chicago School," and read the essay, which critiques the Keynesian philosophy.

Divide the students up into groups of three or four. The students will read the essay and discuss the impact of Keynes and Hayek on the Chicago school of economic thought. Have the students answer the following questions in their group.

Dear Adam:

I enjoyed your and Alex Blumberg's Jan. 29 report on the resurgence of Keynesian economics. In your list of anti-Keynesian schools of thought, though, you missed an important group of scholars: the Austrian economists, whose most prominent exponent was F.A. Hayek. Unlike Keynesians and monetarists, Austrians reject the idea that recessions are due chiefly to aggregate demand being too low. Instead, Austrians focus on the time it takes to correct any misdirections of resources caused by distortions in the complex pattern of individual prices.

Sadly, almost no one today has heard of – and even fewer people pay serious attention to – the Austrian theory. But it was once influential. We have it on the authority of the late Sir John Hicks, himself a Nobel laureate economist, that in the mid-1930s "the new theories of Hayek were the principal rival of the new theories of Keynes."

Keynes's theory cannot adequately explain the experience of the 1970s. Perhaps it's time to look again, not at Keynes's work, but at Hayek's.

Sincerely,

Donald J. Boudreaux

Don Boudreaux is the Chairman of the Department of Economics at George Mason University and a Business & Media Institute adviser.