Frank H. Knight was one of the founders of the so-called Chicago school of economics, of which milton friedman and george stigler were the leading members from the 1950s to the 1980s. Knight made his reputation with his book Risk, Uncertainty, and Profit, which was based on his Ph.D. dissertation. In it Knight set out to explain why “perfect competition” would not necessarily eliminate profits. His explanation was “uncertainty,” which Knight distinguished from risk. According to Knight, “risk” refers to a situation in which the probability of an outcome can be determined, and therefore the outcome insured against. “Uncertainty,” by contrast, refers to an event whose probability cannot be known. Knight argued that even in long-run equilibrium, entrepreneurs would earn profits as a return for putting up with uncertainty. Knight’s distinction between risk and uncertainty is still taught in economics classes today. Knight made three other important contributions to economics. One is The Economic Organization, a set of lecture notes originally published in 1933. In it he laid out the circular flow model of the economy and emphasized that investments will be made until the returns to investments in each use are equal at the margin. These elements still survive in textbooks today. Knight’s famous article “Some Fallacies in the Interpretation of Social Cost,” in which he took on arthur pigou’s view that congestion of roads justified taxation of roads, is another of his contributions to economics. Knight showed that if roads were privately owned, road owners would set tolls that would reduce congestion. Therefore, no government intervention was required. Knight’s final contribution is his work on capital theory in the 1930s. Knight criticized eugen von böhm-bawerk’s view that capital could be measured as a period of production, and is widely thought to have won the debate over the Austrian concept of capital (see austrian school of economics). But Knight was much more than an economist. He was also a social philosopher, and most of his writings are in social philosophy rather than technical economics. A strong believer in freedom and a strong critic of social engineering, Knight worried that freedom would be undermined by increases in monopoly and income inequality. George Stigler tells of Milton Friedman challenging Knight’s view

In 2003, econometrician Clive Granger, along with econometrician Robert Engle, received the Nobel Prize in economics. Granger’s award was “for methods of analyzing economic time series with common trends (cointegration).” Trained in statistics, Granger specializes in the behavior of time-series data (i.e., data that are recorded in calendar sequence, annually or at shorter or longer intervals). Early in his career, the best-developed statistics assumed that time series were stationary—that is, that they tended to vary randomly around a common long-run mean (or average) value or around a nonrandom trend. Many economic time series, however, appear to be nonstationary—to follow processes related to the random walk. The term “random walk” is suggested by the metaphor of a drunken man stumbling in the street—just as likely to go one way as another. A time series is a random walk when the next period’s value is as likely to be higher as it is to be lower, so that the best forecast of the next period’s value is just whatever today’s value happens to be. For lack of better techniques, economists often applied statistics designed for stationary data to nonstationary data. In 1974, Granger and coauthor Paul Newbold, building on the 1920s work of the English statistician G. Udny Yule, showed that pairs of nonstationary time series could frequently display highly significant correlations when there was no causal connection between them. For example, the U.S. federal debt and the number of deaths due to AIDS between 1981 and 2000 are highly correlated but are clearly not causally connected. Such “nonsense correlations” called into question the meaningfulness of many econometric studies. Short-run changes in time series are frequently stationary, even when the time series themselves are nonstationary in the long run. So one strategy in the face of nonstationary data was to study only short-run changes. But Granger (working with Engle) realized that such a strategy threw away valuable information. Not all long-run associations between nonstationary time series are nonsense. Suppose that the randomly walking drunk has a faithful (and sober) friend who follows him down the street from a safe distance to make sure he does not injure himself. Because he is following the drunk, the friend, viewed in isolation, also appears to follow a random walk, yet his path is not aimless; it is largely predictable, conditional on knowing where the drunk is. Granger and Engle coined the term “cointegration” to describe the genuine relationship between two nonstationary time series. Time series are “cointegrated” when the difference between them is itself stationary—the friend never gets too far away from the drunk, but, on average, stays a constant distance back.1 Many economic time series are nonstationary. For example, over long periods, federal revenues and spending appear to be nonstationary, but they also appear to be cointegrated, in the sense that when they are far out of line, they tend to be drawn back into close proximity. Granger developed econometric methods for testing whether the relationships among these time series were genuine cointegrating relationships or nonsense, and for correctly estimating the genuine relationships. In addition to his work on cointegration, Granger is famous for his earlier development of the concept of Granger causality, an idea with roots in the work of the mathematician Norbert Wiener. The current value of a time series is often predictable from its own past values. For example, GDP this quarter is imperfectly predicted from information about GDP over the past few years. A second time series is said to “Granger-cause” another if its past values improve the prediction one would get just from the past values of the first time series. Granger causality is related to cointegration. Granger and Engle demonstrated that when two variables are cointegrated, then at least one of them must Granger-cause the other. The first important application of Granger-causality to economics appears in a 1972 article by Christopher Sims in which he showed that money Granger-causes nominal GNP, apparently bolstering the monetarist idea that fluctuations in money are the major cause of business cycles (see monetarism and milton friedman).2 In the debate that followed, the limits of Granger-causality were clarified: the concept concerns predictability and not control, so that a finding that money Granger-causes GNP does not imply that the Federal Reserve has an effective instrument to steer the economy. While Granger himself had referred simply to “causality,” the adjective “Granger” is now always attached to his idea to distinguish it from causality based on control.3 Granger was born in Wales. He attended the University of Nottingham, where he earned a B.A. in mathematics and economics in 1955 and a Ph.D. in statistics in 1959. He was on the faculty of the University of Nottingham until 1973, with occasional visiting positions at other universities. In 1973, he became a professor at the University of California at San Diego. He retired in 2003, just two months before winning the Nobel Prize. He was knighted in 2005. In reminiscing about his childhood, Sir Clive wrote, “A teacher told my mother that ‘I would never become successful,’ which illustrates the difficulty of long-run forecasting on inadequate data.” About the Author Kevin D. Hoover is professor in the departments of economics and philosophy at Duke University. He is past president of the History of Economics Society, past chairman of the International Network for Economic Method, and editor of the Journal of Economic Methodology. Selected Works   1969. “Investigating Causal Relations by Econometric Models and Cross-Spectral Methods.” Econometrica 37: 424–438. 1974 (with Paul Newbold). “Spurious Regressions in Econometrics.” Journal of Econometrics 2: 111–120. 1981. “Some Properties of Time Series Data and Their Use in Econometric Model Specification.” Journal of Econometrics 16: 121–130. 1987 (with Robert Engle). “Co-integration and Error-Correction: Representation, Estimation and Testing.” Econometrica 55: 251–276.   Footnotes 1. A fuller explication of the notion of cointegration is found in Kevin D. Hoover, “Nonstationary Time Series, Cointegration, and the Principle of the Common Cause,” British Journal for the Philosophy of Science 54 (December 2003): 527–551.   2. Christopher Sims, “Money, Income, and Causality,” American Economic Review 62 (September 1972): 540–552.   3. See Kevin D. Hoover, Causality in Macroeconomics (Cambridge: Cambridge University Press, 2001), esp. chap. 8.   (0 COMMENTS)

In 1989 Norwegian economist Trygve Haavelmo was awarded the Nobel Prize “for his clarification of the probability theory foundations of econometrics and his analyses of simultaneous economic structures.” He made two main contributions in econometrics. The first is a 1943 article that shows some of the statistical implications of simultaneous equations. The second is a 1944 article that bases econometrics more firmly on probability theory. During the war years Haavelmo worked for the Norwegian government in the United States. He was a professor of economics at the University of Oslo from 1948 until his retirement in 1979. Selected Works   1943. “The Statistical Implications of a System of Simultaneous Equations.” Econometrica 11 (January): 1–12. 1944. “The Probability Approach in Econometrics.” Supplement to Econometrica 12 (July): S1–S115. 1960. A Study in the Theory of Investment. Chicago: University of Chicago Press.   (0 COMMENTS)

Roy Harrod is credited with getting twentieth-century economists thinking about economic growth. Harrod built on Keynes’s theory of income determination. The Harrod-Domar model (named for Harrod and Evsey Domar, who worked on the concept independently) is explained in Towards a Dynamic Economics, though Harrod’s first version of the idea was published in “An Essay in Dynamic Theory.” Harrod introduced the concepts of warranted growth, natural growth, and actual growth. The warranted growth rate is the growth rate at which all saving is absorbed into investment. If, for example, people save 10 percent of their income, and the economy’s ratio of capital to output is four, the economy’s warranted growth rate is 2.5 percent (ten divided by four). This is the growth rate at which the ratio of capital to output would stay constant at four. The natural growth rate is the rate required to maintain full employment. If the labor force grows at 2 percent per year, then to maintain full employment, the economy’s annual growth rate must be 2 percent (assuming no growth in productivity). Harrod’s model identified two kinds of problems that could arise with growth rates. The first was that actual growth was determined by the rate of saving and that natural growth was determined by the growth of the labor force. There was no necessary reason for actual growth to equal natural growth, and therefore the economy had no inherent tendency to reach full employment. This problem resulted from Harrod’s assumptions that the wage rate is fixed and that the economy must use labor and capital in the same proportions. But most economists now believe that wage rates can fall when the labor force increases, although they disagree about how quickly. And virtually all mainstream economists agree that the ratio of labor and capital that businesses want to use depends on wage rates and on the price of capital. Therefore, one of the main problems implied by Harrod’s model does not appear to be much of a problem after all. The second problem implied by Harrod’s model was unstable growth. If companies adjusted investment according to what they expected about future demand, and the anticipated demand was forthcoming, warranted growth would equal actual growth. But if actual demand exceeded anticipated demand, they would have underinvested and would respond by investing further. This investment, however, would itself cause growth to rise, requiring even further investment. Result: explosive growth. The same story can be told in reverse if actual demand should fall short of anticipated demand. The result then would be a deceleration of growth. This property of Harrod’s growth model became known as Harrod’s knife-edge. Here again, though, this uncomfortable conclusion was the result of two unrealistic assumptions made by Harrod: (1) companies naïvely base their investment plans only on anticipated output, and (2) investment is instantaneous. In spite of these limitations, Harrod did get economists to start thinking about the causes of growth as carefully as they had thought about other issues, and that is his greatest contribution to the field. Harrod was a close colleague of Keynes, and his official biographer. The Life of John Maynard Keynes was a second, and only slightly less theoretical, product of Harrod’s long association with Keynes. Born in Norfolk, England, Roy Harrod graduated from New College, Oxford. After spending a term at King’s College, Cambridge, where he came in contact with Keynes, Harrod returned to Oxford to administer and teach at Christ Church College until his retirement in 1967. Assar Lindbeck, the chairman of the Nobel Prize Committee, wrote that Harrod would have been awarded a Nobel Prize if he had lived longer. The backlog of other economists awarded the Nobel Prize caused Harrod to miss getting it. Selected Works   1936. The Trade Cycle: An Essay. Oxford: Oxford University Press. 1939. “An Essay in Dynamic Theory.” Economic Journal 49 (March): 14–33. 1948. Towards a Dynamic Economics: Some Recent Developments of Economic Theory and Their Application to Policy. London: Macmillan. 1951. The Life of John Maynard Keynes. London: Macmillan.   (0 COMMENTS)

John C. Harsanyi was corecipient (with John Nash and Reinhard Selten) of the 1994 Nobel Prize in economics “for their pioneering analysis of equilibria in the theory of non-cooperative games.” Harsanyi’s interest in working on game theory was triggered when he read John Nash’s contributions of the early 1950s. He took up where Nash left off. Nash had focused on games in which each player knew the other players’ preferences. Harsanyi wondered how things would change when he introduced the (often more realistic) assumption that players have incomplete information about other players. He assumed that each player is one of several “types.” Each type represents a set of possible preferences for the player and a set of subjective probabilities that that player places on the other players’ types. Each player then chooses a strategy for each of his types. Harsanyi showed that for every game with incomplete information, there is an equivalent game with complete information. The Nobel committee also noted Harsanyi’s contributions to moral philosophy. As early as 1955, Harsanyi had pioneered the “veil of ignorance” concept (though not by that name) that philosopher John Rawls made famous in his 1971 book, A Theory of Justice. Harsanyi was a strong defender of the “rule of utilitarianism,” the idea that the most ethical act is to follow the rule that will yield the most happiness. During his early years Harsanyi escaped from two of the twentieth century’s most vicious totalitarian regimes. He grew up in Hungary in the 1920s and 1930s. He had wanted to study philosophy and mathematics, but because he was of Jewish origin and saw Hitler’s steadily rising influence, he took his parents’ advice and became a pharmacy student, knowing that that would help him maintain a military deferment. In the language of game theory, he “looked forward and reasoned back.” After the German army occupied Hungary, he worked in a “labor unit”—that is, he was a slave—from May to November 1944. When the German government tried to deport him to a concentration camp in Austria, he escaped from the railway station in Budapest. Harsanyi earned his Ph.D. in philosophy at the University of Budapest in 1947 and became a junior faculty member at the University Institute of Sociology. He resigned from the institute in June 1948 because, he recalled, “the political situation no longer permitted them to employ an outspoken anti-Marxist as I had been.” The fact that his wife “was continually harassed by her Communist classmates to break up with” Harsanyi “made her realize … that Hungary was becoming a completely Stalinist country.” In April 1950, he and his wife escaped across the Hungarian border to Austria. “We were very lucky not to be stopped or shot at by the Hungarian border guards,” he wrote.1 Harsanyi moved to Australia, where he spent most of the 1950s. He earned a master’s degree in economics in 1953 and spent two years at Stanford, beginning in 1956, where he earned his Ph.D. in economics. In 1964 he became a professor at the University of California at Berkeley. Selected Works   1950. “Approaches to the Bargaining Problem Before and After the Theory of Games: A Critical Discussion of Zeuthen’s Hicks’s and Nash’s Theories.” Econometrica 24: 144–157. 1955. “Cardinal Welfare, Individualistic Ethics, and Interpersonal Comparisons of Utility.” Journal of Political Economy 63: 309–321. 1967–1968. “Games with Incomplete Information Played by ‘Bayesian’ Players.” Parts I–III. Management Science 14: 159–182, 320–324, and 486–502. 1973. “Games with Randomly Distributed Payoffs: A New Rationale for Mixed Strategy Equilibrium Points.” International Journal of Game Theory 2: 235–250. 1975. “Can the Maximin Principle Serve as a Basis for Morality? A Critique of John Rawls’s Theory.” American Political Science Review 69: 594–606. 1985. “Does Reason Tell Us What Moral Code to Follow, and Indeed, to Follow Any Moral Code at All?” Ethics 96: 42–55.   Footnotes 1. See http://nobelprize.org/economics/laureates/1994/harsanyi-autobio.html.   (0 COMMENTS)

  Though better known for his treatments of philosophy, history, and politics, the Scottish philosopher David Hume also made several essential contributions to economic thought. His empirical argument against British mercantilism formed a building block for classical economics. His essays on money and international trade published in Political Discourses strongly influenced his friend and fellow countryman adam smith. British mercantilists believed that economic prosperity could be realized by limiting imports and encouraging exports in order to maximize the amount of gold in the home country. The American colonies facilitated this policy by providing raw materials that Britain manufactured into finished goods and reexported back to the colonial consumers in America. Needless to say, the arrangement was short-lived. But even before the American Revolution intervened in mercantilistic pursuits, David Hume showed why net exporting in exchange for gold currency, hoarded by Britain, could not enhance wealth. Hume’s argument was essentially the monetarist quantity theory of money: prices in a country change directly with changes in the money supply. Hume explained that as net exports increased and more gold flowed into a country to pay for them, the prices of goods in that country would rise. Thus, an increased flow of gold into England would not necessarily increase England’s wealth substantially. Hume showed that the increase in domestic prices due to the gold inflow would discourage exports and encourage imports, thus automatically limiting the amount by which exports would exceed imports. This adjustment mechanism is called the price-specie-flow mechanism. Surprisingly, even though Hume’s idea would have bolstered Adam Smith’s attack on mercantilism and argument for free trade, Smith ignored Hume’s argument. Although few economists accept Hume’s view literally, it is still the basis of much thinking on balance-of-payments issues. Considering Hume’s solid grasp of monetary dynamics, his misconceptions about money behavior are all the more noteworthy. Hume erroneously advanced the notion of “creeping inflation”—the idea that a gradual increase in the money supply would lead to economic growth. Hume made two other major lasting contributions to economics. One is his idea, later elaborated by friedrich hayek in The Road to Serfdom, that economic freedom is a necessary condition for political freedom. The second is his assertion that “you cannot deduce ought from is”—that is, value judgments cannot be made purely on the basis of facts. Economists now make the same point by distinguishing between normative (what should be) and positive (what is). Hume died the year The Wealth of Nations was published, and in the presence of its author, Adam Smith. Selected Works   1752. Political Discourses. Edinburgh: A. Kincaid and A. Donaldson. Available online at: http://www.econlib.org/library/LFBooks/Hume/hmMPL24.html 1875. The Philosophical Works of David Hume. 4 vols. Edited and annotated by T. H. Green and T. H. Grose. London: Longmans, Green. 1955. Writings on Economics. Edited by Eugene Rotwein. London: Nelson. 1987. Essays: Moral, Political, and Literary. Edited by Eugene F. Miller. Available online at: http://www.econlib.org/library/LFBooks/Hume/hmMPL.html.   (0 COMMENTS)

If any twentieth-century economist was a Renaissance man, it was Friedrich Hayek. He made fundamental contributions in political theory, psychology, and economics. In a field in which the relevance of ideas often is eclipsed by expansions on an initial theory, many of his contributions are so remarkable that people still read them more than fifty years after they were written. Many graduate economics students today, for example, study his articles from the 1930s and 1940s on economics and knowledge, deriving insights that some of their elders in the economics profession still do not totally understand. It would not be surprising if a substantial minority of economists still read and learn from his articles in the year 2050. In his book Commanding Heights, Daniel Yergin called Hayek the “preeminent” economist of the last half of the twentieth century. Hayek was the best-known advocate of what is now called Austrian economics. He was, in fact, the only major recent member of the Austrian school who was actually born and raised in Austria. After World War I, Hayek earned his doctorates in law and political science at the University of Vienna. Afterward he, together with other young economists Gottfried Haberler, Fritz Machlup, and Oskar Morgenstern, joined Ludwig von Mises’s private seminar—the Austrian equivalent of John Maynard Keynes’s “Cambridge Circus.” In 1927 Hayek became the director of the newly formed Austrian Institute for Business Cycle Research. In the early 1930s, at the invitation of Lionel Robbins, he moved to the faculty of the London School of Economics, where he stayed for eighteen years. He became a British citizen in 1938. Most of Hayek’s work from the 1920s through the 1930s was in the Austrian theory of business cycles, capital theory, and monetary theory. Hayek saw a connection among all three. The major problem for any economy, he argued, is how people’s actions are coordinated. He noticed, as Adam Smith had, that the price system—free markets—did a remarkable job of coordinating people’s actions, even though that coordination was not part of anyone’s intent. The market, said Hayek, was a spontaneous order. By spontaneous Hayek meant unplanned—the market was not designed by anyone but evolved slowly as the result of human actions. But the market does not work perfectly. What causes the market, asked Hayek, to fail to coordinate people’s plans, so that at times large numbers of people are unemployed? One cause, he said, was increases in the money supply by the central bank. Such increases, he argued in Prices and Production, would drive down interest rates, making credit artificially cheap. Businessmen would then make capital investments that they would not have made had they understood that they were getting a distorted price signal from the credit market. But capital investments are not homogeneous. Long-term investments are more sensitive to interest rates than short-term ones, just as long-term bonds are more interest-sensitive than treasury bills. Therefore, he concluded, artificially low interest rates not only cause investment to be artificially high, but also cause “malinvestment”—too much investment in long-term projects relative to short-term ones, and the boom turns into a bust. Hayek saw the bust as a healthy and necessary readjustment. The way to avoid the busts, he argued, is to avoid the booms that cause them. Hayek and Keynes were building their models of the world at the same time. They were familiar with each other’s views and battled over their differences. Most economists believe that Keynes’s General Theory of Employment, Interest and Money (1936) won the war. Hayek, until his dying day, never believed that, and neither do other members of the Austrian school. Hayek believed that Keynesian policies to combat unemployment would inevitably cause inflation, and that to keep unemployment low, the central bank would have to increase the money supply faster and faster, causing inflation to get higher and higher. Hayek’s thought, which he expressed as early as 1958, is now accepted by mainstream economists (see phillips curve). In the late 1930s and early 1940s, Hayek turned to the debate about whether socialist planning could work. He argued that it could not. The reason socialist economists thought central planning could work, argued Hayek, was that they thought planners could take the given economic data and allocate resources accordingly. But Hayek pointed out that the data are not “given.” The data do not exist, and cannot exist, in any one mind or small number of minds. Rather, each individual has knowledge about particular resources and potential opportunities for using these resources that a central planner can never have. The virtue of the free market, argued Hayek, is that it gives the maximum latitude for people to use information that only they have. In short, the market process generates the data. Without markets, data are almost nonexistent. Mainstream economists and even many socialist economists (see socialism) now accept Hayek’s argument. Columbia University economist Jeffrey Sachs noted: “If you ask an economist where’s a good place to invest, which industries are going to grow, where the specialization is going to occur, the track record is pretty miserable. Economists don’t collect the on-the-ground information businessmen do. Every time Poland asks, Well, what are we going to be able to produce? I say I don’t know.”1 In 1944 Hayek also attacked socialism from a very different angle. From his vantage point in Austria, Hayek had observed Germany very closely in the 1920s and early 1930s. After he moved to Britain, he noticed that many British socialists were advocating some of the same policies for government control of people’s lives that he had seen advocated in Germany in the 1920s. He had also seen that the Nazis really were National Socialists; that is, they were nationalists and socialists. So Hayek wrote The Road to Serfdom to warn his fellow British citizens of the dangers of socialism. His basic argument was that government control of our economic lives amounts to totalitarianism. “Economic control is not merely control of a sector of human life which can be separated from the rest,” he wrote, “it is the control of the means for all our ends.” To the surprise of some, John Maynard Keynes praised the book highly. On the book’s cover, Keynes is quoted as saying: “In my opinion it is a grand book…. Morally and philosophically I find myself in agreement with virtually the whole of it; and not only in agreement with it, but in deeply moved agreement.” Although Hayek had intended The Road to Serfdom only for a British audience, it also sold well in the United States. Indeed, Reader’s Digest condensed it. With that book Hayek established himself as the world’s leading classical liberal; today he would be called a libertarian or market liberal. A few years later, along with Milton Friedman, George Stigler, and others, he formed the Mont Pelerin Society so that classical liberals could meet every two years and give each other moral support in what appeared to be a losing cause. In 1950 Hayek became professor of social and moral sciences at the University of Chicago, where he stayed until 1962. During that time he worked on methodology, psychology, and political theory. In methodology Hayek attacked “scientism”—the imitation in social science of the methods of the physical sciences. His argument was that because social science, including economics, studies people and not objects, it can do so only by paying attention to human purposes. The Austrian school in the 1870s had already shown that the value of an item derives from its ability to fulfill human purposes. Hayek was arguing that social scientists more generally should take account of human purposes. His thoughts on the matter are in The Counter-Revolution of Science: Studies in the Abuse of Reason. In psychology Hayek wrote The Sensory Order: An Inquiry into the Foundations of Theoretical Psychology. In political theory Hayek gave his view of the proper role of government in his book The Constitution of Liberty. It is actually a more expansive view of the proper role of government than many of his fellow classical liberals hold. He discussed the principles of freedom and based his policy proposals on those principles. His main objection to progressive taxation, for example, was not that it causes inefficiency but that it violates equality before the law. In the book’s postscript, “Why I Am Not a Conservative,” Hayek distinguished his classical liberalism from conservatism. Among his grounds for rejecting conservatism were that moral and religious ideals are not “proper objects of coercion” and that conservatism is hostile to internationalism and prone to a strident nationalism. In 1962 Hayek returned to Europe as professor of economic policy at the University of Freiburg in Breisgau, West Germany, and stayed there until 1968. He then taught at the University of Salzburg in Austria until his retirement nine years later. His publications slowed substantially in the early 1970s. In 1974 he shared the Nobel Prize with Gunnar Myrdal “for their pioneering work in the theory of money and economic fluctuations and for their penetrating analysis of the interdependence of economic, social and institutional phenomena.” This award seemed to breathe new life into him, and he began publishing again, both in economics and in politics. Many people get more conservative as they age. Hayek became more radical. Although he had favored central banking for most of his life, in the 1970s he began advocating denationalizing money. Private enterprises that issued distinct currencies, he argued, would have an incentive to maintain their currency’s purchasing power. Customers could choose from among competing currencies. Whether they would revert to a gold standard was a question that Hayek was too much of a believer in spontaneous order to predict. With the collapse of communism in Eastern Europe, some economic consultants have considered Hayek’s currency system as a replacement for fixed-rate currencies. Hayek was still publishing at age eighty-nine. In his book The Fatal Conceit, he laid out some profound insights to explain the intellectuals’ attraction to socialism and then refuted the basis for their beliefs. Selected Works   1931. “Richard Cantillon.” Translated by Micheál Ó Súilleabháin in the Journal of Libertarian Studies 7, no. 2 (1985): 217–247. Available online at: http://www.econlib.org/library/Essays/JlibSt/hykCnt1.html. 1935. Prices and Production. 2d ed. Reprint. New York: Augustus M. Kelley, 1975. 1937. “Economics and Knowledge.” Economica, n.s., 4 (February): 33–54. Reprinted in James M. Buchanan and G. F. Thirlby, eds., L.S.E. Essays on Cost. London: Weidenfeld and Nicolson, 1973. Available online at: http://www.econlib.org/library/NPDBooks/Thirlby/bcthLS3.html. 1939. “Price Expectations, Monetary Disturbances, and Malinvestments.” In Hayek, Profits, Interest, and Investment. Reprint. New York: Augustus M. Kelley, 1975. 1944. The Road to Serfdom. Chicago: University of Chicago Press. 1945. “The Use of Knowledge in Society.” American Economic Review 35 (September): 519–530. Available online at: http://www.econlib.org/library/Essays/hykKnw1.html. 1948. Individualism and Economic Order. Chicago: University of Chicago Press. 1952. The Counter-Revolution of Science: Studies on the Abuse of Reason. Glencoe, Ill.: Free Press. 1960. The Constitution of Liberty. Chicago: University of Chicago Press. Reprint. Chicago: Henry Regnery, 1972. 1973. Law, Legislation, and Liberty. Chicago: University of Chicago Press. 1976. Denationalization of Money. London: Institute of Economic Affairs. 1977. Foreword to Economics as a Coordination Problem: The Contributions of Friedrich A. Hayek by Gerald P. O’Driscoll Jr. Kansas City: Sheed, Andrews, and McMeel. 1988. The Fatal Conceit. Chicago: University of Chicago Press. 1995. Introduction to Selected Essays on Political Economy by Frédéric Bastiat. Trans. from the French by Seymour Cain. Edited by George B. de Huszar. Princeton: Van Nostrand, 1995. Available online at: http://www.econlib.org/library/Bastiat/basEss0.html#Introduction,byF.A.Hayek.   Footnotes 1. “Interview: Jeffrey Sachs,” Omni 13, no. 9 (1991) p. 79.   (0 COMMENTS)

  Walter Heller’s claim to fame stems from his years as chairman of the Council of Economic Advisers (CEA) from 1961 to 1964, under presidents John F. Kennedy and Lyndon B. Johnson. Before that, and after, he was an economics professor at the University of Minnesota. As chairman of the CEA, Heller persuaded President Kennedy to cut marginal tax rates. This cut in tax rates, which was passed after Kennedy’s death, helped cause a boom in the U.S. economy. Heller’s CEA also developed the first “voluntary” (i.e., enforced by veiled threats rather than by explicit laws) wage-price guidelines. Heller’s early academic work was on state and local taxation. In 1947 and 1948 he was tax adviser to the U.S. military government in Germany. He was involved in the currency and tax reforms that helped spur the German economic boom (see german economic miracle). In a 1950 article, Heller noted that the reduction in marginal tax rates helped “remove the repressive effect of extremely high rates.” According to tax economist Joseph Pechman, Heller was also one of the first economists to recognize that tax deductions and tax preferences narrow the income tax base, thus requiring, for a given amount of revenue, higher marginal tax rates. Selected Works   1949. “Tax and Monetary Reform in Occupied Germany.” National Tax Journal 2, no. 3: 215–231. 1966. New Dimensions of Political Economy. Cambridge: Harvard University Press. 1969 (with Milton Friedman). Monetary vs. Fiscal Policy. New York: W. W. Norton. 1975. “What’s Right with Economics?” American Economic Review 65, no. 1: 1–26.   (0 COMMENTS)

  Harry Johnson, a Canadian, was one of the most active and prolific economists of all time. His main research was in the area of international trade, international finance, and monetary policy. One of Johnson’s early articles on international trade showed that a country with monopoly power in some good could impose a tariff and be better off, even if other countries retaliated against the tariff. His proof was what is sometimes called a “possibility theorem”; it showed that such a tariff could improve the country’s well-being, not that it was likely to. Johnson, realizing the difference between what could be and what is likely to be, was a strong believer in free trade. Indeed, he often gave lectures in his native Canada excoriating the Canadian government for its protectionist policies and arguing that Canada could eliminate some of the gap between Canadian and U.S. standards of living by implementing free trade. In international finance Johnson’s seminal 1958 paper named the growth in the money supply as one important factor that affects a country’s balance of payments. Before then, economists had tended to focus on nonmonetary factors. Johnson’s article began what is now called the monetary approach to the balance of payments. In the field of monetary economics Johnson made an early attempt to do for Britain what milton friedman and Anna Schwartz were doing for the United States: measure the money supply over time. Although he did not achieve as much in this area as Friedman and Schwartz did, his work led to other, more careful and detailed studies of the British money supply. In 1959, after having been a professor at the University of Manchester in England, Johnson moved to the University of Chicago as the token “Keynesian.” He learned a lot from monetarist Milton Friedman and others at Chicago, just as he had learned from Keynesians in England. Although never a monetarist himself, Johnson became increasingly sympathetic to monetarist views. One of his classic articles, written in his early years at Chicago, is his 1962 survey, “Monetary Theory and Policy.” The article is a graduate student’s delight—tying together apparently disparate insights by other economists, pointing out their pitfalls, and laying out an agenda for future research—all in a clear, readable style that still manages not to sacrifice subtle distinctions. In a relatively short career Johnson wrote 526 professional articles, forty-one books and pamphlets, and more than 150 book reviews. He also gave a prodigious number of speeches. According to paul samuelson, when Johnson died he had eighteen papers in proof. (Commented Samuelson: “That is dying with your boots on!”) Johnson also earned many honors. In 1977, for example, he was named a distinguished fellow of the American Economic Association, and in 1976 the Canadian government named him an officer of the Order of Canada. Johnson graduated from the University of Toronto in 1943 and earned his Ph.D. from Harvard in 1958. Selected Works   1953. “Optimum Tariffs and Retaliation.” Review of Economic Studies 21, no. 2: 142–153. 1959. “British Monetary Statistics.” Economica 26 (February): 1–17. 1961. “The ‘General Theory’ After Twenty-five Years.” American Economic Review 51 (May): 1–17. 1963. The Canadian Quandary: Economic Problems and Policies. Toronto: McGraw-Hill. 1969. Essays in Monetary Economics. 2d ed. Cambridge: Harvard University Press. 1971. “The Keynesian Revolution and the Monetarist Counter-revolution.” American Economic Review 61 (May): 1–14. 1972. Further Essays in Monetary Economics. London: George Allen and Unwin.   (0 COMMENTS)

  In 2002, Daniel Kahneman, along with Vernon Smith, received the Nobel Prize in economics. Kahneman received his prize “for having integrated insights from psychological research into economic science, especially concerning human judgment and decision-making under uncertainty.” Kahneman did most of his important work with Amos Tversky, who died in 1996. Before their work, economists had gotten far in their analyses of decision making under uncertainty by assuming that people correctly estimate probabilities of various outcomes or, at least, do not estimate these probabilities in a biased way (see Rational Expectations). Even if some people place too low a probability on an event relative to what was reasonable, economists argued, others will place too high a probability on that same event and the results would cancel out. But Kahneman and Tversky found that this is not true: the vast majority of people misestimate probabilities in predictable ways. One bias they found is that people tend to believe in “the law of small numbers”; that is, they tend to generalize from small amounts of data. So, for example, if a mutual fund manager has had three above-average years in a row, many people will conclude that the fund manager is better than average, even though this conclusion does not follow from such a small amount of data. Or if the first four tosses of a coin give, say, three heads, many people will believe that the next toss is likely to be tails. Kahneman saw this belief in his own behavior as a young military psychologist in the Israeli army. Tasked with evaluating candidates for officer training, he concluded that a candidate who performed well on the battlefield or in training would be as good a leader later as he showed himself to be during the observation period. As Kahneman explained in his Nobel lecture, “As I understood clearly only when I taught statistics some years later, the idea that predictions should be less extreme than the information on which they are based is deeply counterintuitive.”1 Another bias Kahneman and Tversky found to be common in people’s thinking is “availability,” whereby people judge probabilities based on how available examples are to them. So, for example, people overstate the risk from driving without a seat belt if they personally know someone who was killed while driving without. Also, repetition of various stories in the news media, such as stories about children being killed by guns, causes people to overstate the risk of guns to children (see risk and safety). Kahneman and Tversky also introduced “prospect theory” to explain some systematic choices most people make—choices that contradict the strictly rational model. Kahneman later admitted that their theory’s name was meaningless, but that it was important for getting others to take it seriously, thus giving even more evidence that the framing of an issue matters. (See the next paragraph for an example.) Imagine, for example, that someone is given a chance to bet $40 on some outcome and that he is told, accurately, that his probability of winning $40 is 60 percent, which means that his probability of losing $40 is 40 percent. Most people will refuse such a bet. Kahneman and Tversky called this “loss aversion.” This could be written off as simple risk aversion, which is certainly not irrational. What makes it strange, if not outright irrational, is that people act so differently with bigger gambles. Kahneman and Tversky found, for example, that seven out of ten people prefer a 25 percent probability of losing $6,000 to a 50 percent probability of losing either $4,000 or $2,000, with an equal probability (25 percent) for each. In each case the expected loss—that is, the loss multiplied by its probability, is $1,500. But here they prefer the bigger loss ($6,000) to the smaller one ($2,000 or $4,000). This choice demonstrates what economists calling risk-loving behavior, the opposite of the risk aversion noted for the smaller bets. Kahneman and Tversky also used prospect theory to explain other systematic behavior that departs from the economist’s rationality assumption. Consider the following situation. Many people will drive an extra ten minutes to save $10 on a $50 toy. But they will not drive ten minutes to save $20 on a $20,000 car. The gain from driving the extra ten minutes for the car is twice the gain of driving the extra ten minutes for the toy. So a higher percentage, not a lower one, of people should drive the longer distance for the saving on the car. Why don’t they? Kahneman’s and Tversky’s explanation is that the framing of the issue affects the decision. Instead of comparing the absolute saving in price against the cost of going the extra distance, people compare the percentage saving, and the percentage saving in the case of the car is very small. Kahneman’s and Tversky’s work spurred a great deal of work by economists on systematic departures from rational behavior. See behavioral economics for an introduction to many of the issues. Kahneman was born in Tel Aviv, Israel, and grew up in France. He earned his B.A. in psychology and mathematics at Hebrew University in 1954 and his Ph.D. in psychology from the University of California at Berkeley in 1961. He was a psychology professor at Hebrew University from 1961 to 1978, at the University of British Columbia from 1978 to 1986, at the University of California at Berkeley from 1986 to 1994, and has been a professor at Princeton University since 1993. Selected Works   1972 (with Amos Tversky). “Subjective Probability: A Judgment of Representativeness.” Cognitive Psychology 3: 430–454. 1973 (with Amos Tversky). “On the Psychology of Prediction.” Psychological Review 80: 237–251. 1974 (with Amos Tversky). “Judgment Under Uncertainty: Heuristics and Biases.” Science 185: 1124–1131. 1979 (with Amos Tversky). “Prospect Theory: An Analysis of Decision Under Risk.” Econometrica 47: 263–291. 1986 (with Jack Knetsch and Richard Thaler). “Fairness and the Assumptions of Economics.”Journal of Business 59: S285–S300.   Footnotes 1. See http://nobelprize.org/economics/laureates/2002/kahnemann-lecture.pdf.   (0 COMMENTS)