I do a lot of bashing of the "Chicago School" of economics, as do a lot of other people. But it's important to remember that the ideological nutsos are only one chunk of the department there. John Cassidy's series of interviews for the New Yorker demonstrates that there are some extremely reasonable, well-grounded superstars at Chicago.
Take Nobel prize-winner Gary Becker, for instance:
Gary Becker: I think the last twelve months have shown that free markets sometimes don’t do a very good job. There’s no question, financial markets in the United States and elsewhere didn’t do a good job over this period of time, but if I take the first proposition of Chicago economics—that free markets generally do a good job—I think that still holds...[Judge Richard] Posner says that the government’s interventions have staved off another Great Depression.
[Becker]: Market economists—take my teacher and close friend Milton Friedman: [he was] a big advocate that the government should have done more during the Depression. The Fed should have done more. It was too passive and the money supply dropped, and so on. So it’s been long recognized that there are situations when you need very strong, temporary government interventions. [Policymakers] did come in here, and they did help...
Two of the big theories associated with Chicago are the efficient-markets hypothesis and the rational-expectations hypothesis, both of which, some say, have been called into question. How do you react to that?
[Becker]:Well, these are not areas that I have particularly specialized in, but let me give you my reaction. The people who argue that markets were always efficient and there was no problem, that was an extreme position—something a lot of people at Chicago had recognized before...
Yeah, markets aren’t fully efficient. Expectations go wrong. We’ve seen many other episodes in the past where expectations have gone wrong, where it looks like there were bubbles that happened...Nevertheless, the notion that people are forward looking and try to get things right, and often they do get things right—I still think that comes through O.K. You just have to be more qualified and more careful in how you state it...
But what about speculative bubbles? I recall interviewing Milton Friedman, in 1998, I think, and he said he thought the stock market was in a bubble. The idea that Chicago economists don’t believe in bubbles—was that more Greenspan?
[Becker]: Absolutely. I think bubbles have been recognized. Certainly, Friedman and others, including myself, said there are phenomena that are hard to explain without thinking it’s a bubble...I don’t think there’s any question about that. I don’t think that most Chicago School economists thought that these things didn’t happen. I think most Chicago economists recognized that, and, certainly, Milton Friedman did.
The models that Bob Lucas is associated with—rational expectations, dynamic general equilibrium models, and so on. Some people now say that they omitted so much—the entire financial sector was excluded—that they left the economics profession unprepared for this type of eventuality.
[Becker]: I think some of the dynamic general equilibrium models that were being promoted in macro didn’t turn out to be that helpful in helping us to understand what to do to combat a major recessionary event...So I think there is some validity to that conclusion...Some people did rule out the whole financial sector, seeing money as being unimportant. I think that stuff just turned out to be wrong...
Do you think that Wall Street needs re-regulating?
[Becker]: Well, I do. I think some additional regulation is needed, and I’ve called for some. But I don’t think you can rely on regulators, because they fail along with the market. If we install rules for capital requirement that would work more or less automatically—I think there is a good case for that, particularly for larger institutions which we know we are going to bail out if they get into trouble...
So people at Chicago did accept the need for dealing with externalities? What about Ronald Coase? [Coase, an English transplant who won the Nobel Prize in 1991, is famous for arguing that, under some circumstances, bargaining in the market will take care of externalities.]
[Becker]: Chicago didn’t deny that there were externalities in the world. Chicago people were not anarchists. They always believed there was a significant role for government, and not simply in the obvious areas, like law and the military, and so on.
Was there anything, looking back, that Chicago got wrong?
[Becker]: (Laughs) There are a lot of things that people got wrong, that I got wrong, and Chicago got wrong. You take derivatives and not fully understanding how the aggregate risk of derivatives operated. Systemic risk. I don’t think we understood that fully, either at Chicago or anywhere else…You can go on. Global warming. Maybe initially at Chicago there was skepticism towards that. But the evidence got stronger and people accepted it was an important issue.
Another example of a very sane and reasonable Chicago economist is Nobel prize-winner James Heckman.
Now contrast this with the drivel that is spouted by Eugene Fama in his own interview. It's like night and day.
I think it's no surprise that when I read papers by Becker or Heckman, I find myself thinking "Yes, OK, this is interesting and I understand this." But when I read papers by nutsos like Fama, I find myself just shaking my head and thinking "Nonsense...absurd...ridiculous...time to go watch cartoons on DVD..."
The problem with Chicago is that the big nutsos - Bob Lucas, Eugene Fama, and John Cochrane - are largely the guys who are devoted to "studying" macro and finance, while the sane guys are largely in other fields (Becker studies applied microeconomics, Heckman is essentially a statistician). The macro field has been politicized, so that only people who preach the semi-official nutso dogma of rational expectations, efficient markets, etc. can be allowed in the temple.
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