I wanted to do a follow up argument on the article about Milton Friedman to make some things clear.  I think that overall, Milton Friedman was a positive influence on American economic policy.  The Chicago School’s influence has been a net positive for the country. The Chicago School and the Austrian school agree on many things but, the differences are critical to economic understanding; they are not just some obscure disagreements by academia.  I want to address these issues in order.

1. The Chicago School has no concept of the Austrian Business Cycle Theory nor does it have any understanding of how booms and busts happen.  In fact, according to the Chicago School, booms and busts should not happen at all because markets always level out naturally(which would likely be true if it was not for the Fed) according to their theory of “efficient market hypothesis” as can be seen here, here, and here.  This is why all the Austrian Economists were able to see the bust of 2008 coming from miles away while the Chicago School economists did not have a clue even while it was happening.  This can be seen in the first video in the previous article where the famous “Supply Sider”, Art Laffer, says that “no way a bust is coming”, the economy is good and monetary policy has been “great”.  If Art Laffer’s statement does not make you question the Chicago School’s way of thinking then something is very wrong.

2. The Chicago School’s cure for a depression is the exact same as that which the Keynesians’ and Ben Bernanke would come up with.  Milton Friedman wrote that the problem during the Great Depression was that the Federal Reserve did not inflate enough.  Well, Ben Bernanke has taken Milton Friedman’s message to heart and has put the printing presses into overdrive.  Thank goodness we have such wise leaders running things or we would be in real trouble!  Only recently have Chicago School economists started to question Ben Bernanke about low interest rates, not because they are inflationary but, because the inflation is extended for too long a time period, “mitigating its positive effects”.

3. The Chicago School are inflationists to the very core and think that central banks should inflate at a steady rate  of about 2% to 4% per annum.  Not only are there many economic problems associated with this, such as a misallocation of resources but there are moral and practical implications as well.  The moral implication is that inflation, even at 2%, redistributes wealth from the poor and the middle class to the rich.  The practical implication is that trusting politicians and bankers with the moral fortitude to keep inflation at 2% is completely naive.  Simply put, the short term political advantages to inflation are too tempting to pass up.  This can be seen time and time again, especially in the last thirty years, where Greenspan inflated bubble after bubble because it was politically expedient.

4. Lastly, the Chicago School is pretty much OK with central planning in a philosophical sense.  Remember, their objections to government intervention into the free market are not out of a deep understanding of property rights, natural law, individual sovereignty or hostility to command and control economies but, because they generally think that most market intervention does not make the economy more efficient.  The Chicago School’s obsession with “market efficiency” can be seen in all the other areas where they do support government involvement (like monopoly laws).   This article expands upon it more but, basically if communist societies were more economically efficient, then the Chicago School economists would be theoretically in favor of them. Whether the idea of market efficiency is valid at all theoretically is a whole other question but, I think that Mises put that idea into the grave with his book Human Action.

Although the Chicago School has some positive influence in reducing regulation and promoting free trade, its deficiencies are now too glaring to ignore.  It is also important to understand that the Chicago School rose to prominence not because of its intellectual merits but, because of the Keynesians’ complete inability to explain the stagflation of the 1970s.  Long story short, the Chicago School was the only other game in town (the Austrian School was still obscure at the time).

In conclusion, I think that we are all very blessed to be living during a new revival of the Austrian School.  So, if you liked reading Milton Friedman, you will love reading Mises, Hayek, and especially Rothbard.

So you are a good free market Chicago School guy.  You have rejected Keynesian economics in favor of the free market Chicago school.  You have read Milton Friedman’s “Right to Choose” and you are convinced that the free market is the way to go.

Well, maybe he is not such a free market guy.  He is, in fact, in favor of compulsory taxation, monopoly, price controls, and the welfare state.  Milton Friedman proposed the tyrannical payroll deduction in the United Sates during WW2 and it has stuck with us like a curse ever since.  He is against cartels in most areas except for money.  Though Chicago School has done many positive things in promoting liberty, its faults are glaring and can no longer be ignored after September 2008. The Chicago School was fundamental in popularizing the idea that almost all government regulations are actually lobbied for and constructed by the industries that are to be regulated to push out competition and raise costs for new competitors entering the sector.  This allows large firms to absorb regulatory costs while pushing out small businesses and new upstart companies.  The term popularized by many from the Chicago school is “Cui Bono” or who benefits?.  The Chicago School realized that in almost all cases, the big players in the industries being regulated are almost always the same beneficiaries of such regulations and are also the biggest pushers of regulation (just like today’s health care legislation and insurance companies.)  Chicago School has written hundreds of books on almost every industry when making their case but have somehow missed the elephant in the room, the Federal Reserve. So the largest monopoly of all escapes all scrutiny from the Chicago School.  Chicago School refuses to use this same method of “Cui Bono?” on the banking cartels that exist around the world in the form of Central Banks.  This seems absurd when considering that all the shareholders of central banks are private and have enormous leverage in setting the price for money (the interest rate).  So the Chicago School and Milton are completely inconsistent in their theories when it comes to money.  They are for free competition in all fields except for banking, where the Chicago school supports government sponsered monopoly.

When it comes to methodology, the Chicago School is as bad if not worse than the Keynesians.  The Chicago School and every other school of economic thought besides the Austrian School since the 1930s have viewed human beings as mathematical aggregates.  That is to say, human beings are simply numbers to be put in mathematical formulas.  The Austrian School completely rejects this because human beings are conscious actors that change their behaviors based on conditions. For example if you raise the income tax, some people will likely find other ways to generate income through investment or some other method.  Therefore, human behavior and concious actors will change how much revenue will be brought in.  All other schools of thought pretend that human behavior is for the most part unchanging and can be constructed as part of a mathematical formula. For example, if government action A is taken than B will be the result.  Ludwig Von Mises established in “Human Action” that human behavior cannot be predicted and observed in the same way that hard sciences make predictions. All particles in the universe act in the same predictable way when a force is applied to them. This is not true with human behavior.  When a new variable is applied to human interaction, humans will react in multiple different ways, each to achieve their own desired goals. Since economists can’t possibly know the goals and motives of every single person, it makes human beings almost impossible to predict the same way that chemists or other scientists make predictions with their respective studies.  This puts economics closer to the field of sociology rather than a hard science, i.e. physics, that mainstream economists’ fantasize about making economics into.  Human beings are conscious actors but the Chicago School’s methodology leads to many conclusions that are not logical because they often do not take this into account. Murray Rothbard gives the example of Milton Friedman’s negative income tax or guaranteed annual income.  Rothbard argues that it is precisely because the welfare bureaucracy is so inefficient that the United Sates is not more bankrupt than it is.  Friedman’s plan to make it more efficient by automatically sending out checks to anyone making below a certain income creates a hugely distorted incentive structure that is logically obvious but which Chicago School’s methodology seems unable to grasp.

Lastly if you still think that the Chicago School is free market consider this; Ben Bernanke is a student of the Chicago School, specifically Milton Friedman’s book on the Great Depression. Everything that Ben Bernanke has done has been lock step with what Milton Friedman had suggested should have been done during the Great Depression. Not one major economist from the Chicago School publicly protested against TARP or the mind boggling expansion of the money supply.  The Chicago School has completely capitulated to the Keynesian world view and have shown their true colors. The only school of thought that has not been toppled in the wake of September 2008 has been the Austrian School.

Here Gary North goes into some of the intellectual history of economics. Additionally, Gary North makes the argument that the intervention of 2008 was so massive that it was arguably taken even further than anything that Milton Friedman would have suggested thirty years ago.

Here is another lecture comparing Milton Friedman to the Keynesian paradigm.

Here is an article about how mainstream conservatives and supply siders are Keynesian.

It is critical for everyone to understand Austrian Business Cycle Theory because it affects everything. The main idea is rather simple while some of the details are a bit more hard to understand.  Austrian Business Cycle theory simply states that  booms and busts exist and that they are not unpredictable market phenomena. They are in fact very predictable because they are caused by an outside agency (central banks in most cases).  This allows the average person to avoid massive monetary losses by allowing them to identify bubbles before they pop such as the dot com bubble and the housing bubble.  This also allows the average person to make huge profits because they can identify the next bubble at the ground floor and place their money there before the public enters that particular bubble sector in mass.

Here is the famous Peter Schiff video where he predicts exactly how the crash of September 2008 happened (started in sub-prime, spread to the rest of the housing sector and then finally to the financial sector).  My favorite part is how he takes on Art Laffer (creator of the famous Laffer Curve which absurdly proposes that lower taxes bring in more tax revenue; this idea is actually believed to be true by people you may have heard of such as Sean Hannity.) Laffer is also one of the most well known of the Reagan era supply side economists that act like they are free market but, as demonstrated in this video, are actually just soft keynesians.

Here is an explanation of the Austrian Business Cycle from an academic perspective:

Here are some more brief versions:

Austrian Business Cycle

Tom Woods explains the Austrian Business cycle theory to a group of students in Boulder.

I like this speech because Tom is explaining the Fed to economic students that are mostly skeptics of Austrian Business Cycle theory.   This speech is also enjoyable because it assumes that the audience has some understanding of economics above your average citizen.  Tom Wood’s assumption that the audience has intelligence allows him to skip past the more basic economic ideas and get right in to the thick of it.

http://www.youtube.com/watch?v=541bajR4k8g