In the introduction to Activity Analysis of Production and Allocation (Cowles Monograph No. 13), Tjalling C. Koopmans recalled that he developed the model of his “Optimal Utilization of the Transportation System” (in the proceedings of 1947 International Statistical Congress, which were reissued as an Econometrica supplement, 1949) “under the stimulation of statistical work for the Combined Shipping Adjustment Board, the British-American board dealing with merchant shipping problems during the second world war.” Similarly, the contributions of George B. Dantzig and Marshall K. Wood to Cowles Monograph No. 13 (two revised journal articles and five new chapters) emerged from wartime work for the US Army Air Force and postwar work for the Department of the Air Force. This article examines the context and consequences of the wartime roots of these foundational contributions to activity analysis and linear programming, with particular attention to Koopmans's 1942 memorandum for the Combined Shipping Adjustment Board titled “Exchange Ratios between Cargoes on Various Routes” (first published in his Scientific Papers, 1970).
Harry Markowitz’s pioneering work on portfolio choice was developed in the supportive environment of the Cowles Commission (later Foundation), a remarkable organization devoted to advanced formal mathematical and statistical methods in economics. Markowitz made use of Tjalling Koopmans’s activity analysis and influenced the monetary and financial economics of James Tobin and his Cowles associates, who studied the implications for economic equilibrium of investors following Markowitz’s optimal portfolio diversification. Milton Friedman’s reluctance to accept Markowitz’s dissertation was part of growing methodological frictions between Friedman and the Cowles Commission that led the commission to leave the University of Chicago to become the Cowles Foundation at Yale.
The American Keynesian economist and Nobel laureate James Tobin entitled his contribution to the inaugural issue of Journal of Money, Credit and Banking “A General Equilibrium Approach to Monetary Theory” (1969) yet he was sharply critical of the version of general equilibrium analysis used in the now-prevalent dynamic stochastic general equilibrium (DSGE) approach to macroeconomic modeling. He also rejected claims that overlapping generation (OLG) models provided a choice-theoretic foundation for the holding of fiat money, denying that the assumption that people held fiat money because no other asset existed was less arbitrary than allowing costs of transactions between assets to be non-zero. Yet, while not accepting OLG as the explanation of why people hold fiat money, Tobin, in a series of articles from 1967 to 1983 (some joint with Walter Dolde), placed the life-cycle model of consumption and saving (whose origins he attributed to an earlier Yale economist, Irving Fisher) into an OLG setting. This article examines Tobin’s critiques of DSGE and OLG modelling in macroeconomics, what he meant by “a general equilibrium approach to monetary theory,” and his contribution placing the life-cycle model in an OLG setting.
The Nobel Prize-winning work of Harry Markowitz (1952, 1959) at the Cowles Commission and Cowles Foundation established optimal portfolio diversification (minimizing risk for a given expected return) as central to financial theory. Much less attention has been given to the frst Cowles Commission study to show that diversification reduced portfolio risk: Dickson Leaven’s article “Diversification of Investments” (published in Trusts and Estates, 1945). Leavens, a statistician on the Cowles Commission staff and author of a Cowles monograph on silver money, came to this insight as the result of computing returns on twenty randomly-selected portfolios for Alfred Cowles to use in Cowles’s 1944 Econometrica article “Stock Market Forecasting,” which argued that, with one apparent exception, stock market forecasters had failed to out-predict random portfolios. We present Leavens’ little-known contribution and explore his role in the development of financial economics at the Cowles Commission.
Under the directorship of Jacob Marschak (1943-48) and Tjalling Koopmans (1948-55), the Cowles Commission at the University of Chicago sponsored pioneering work on general equilibrium, social choice, activity analysis, and simultaneous-equations econometric models by Kenneth Arrow, Gerard Debreu, Trygve Haavelmo, Leonid Hurwicz, Lawrence Klein, Harry Markowitz, and Herbert Simon, all, like Koopmans, future Nobel laureates. The Cowles Commission’s methodology was contested by the emerging Chicago school of economics, led by future Nobel laureates Milton Friedman and Theodore Schultz (department chair 1946-61) who upheld partial equilibrium price theory, the quantity theory and rational choice against the Cowles emphasis on general equilibrium and Keynesian macroeconomics and against Simon’s bounded rationality, and who were suspicious of Cowles projects on activity analysis and macroeconometric models as creating tools for central planning and Keynesian demand management. We examine the interactions and methodological debates between the two groups, which led to the departure of the Cowles Commission to Yale University in 1955.
Presented at a History of Economics Society session on “The Cowles Commission and Foundation: Transforming and Formalizing Economics,” Allied Social Science Associations annual meetings, San Diego, California, January 5, 2020. We are grateful to the late Olav Bjerkholt for providing us with a copy of the memorandum from Friedman to Willets at the Rockefeller Foundation and to Harald Hagemann for drawing our attention to the 1938 letter from Cowles to Marschak in the Marschak Papers. Robert Dimand thanks the Cowles Foundation and the Université de Haute Alsace for visiting fellowships.
From 1975 onwards, James Tobin changed his interpretation of the Keynesian case that active stabilisation policy is sometimes needed to restore full employment, offering a new interpretation that drew on Keynes’s General Theory and on Irving Fisher’s 1933 debt-deflation theory of depressions to argue that wage and price flexibility could be destabilizing. Like Hyman Minsky and Peter Howitt, Tobin stressed the previously underappreciated Chapter 19 of The General Theory, where Keynes argued that faster adjustment of prices and money wages could be destabilising. The basis of Keynesian macroeconomics was coordination failure and instability, not irrational money illusion or an arbitrary assumption of a fixed money wage.
Commitment to the behaviorist approach to utility theory, to the usefulness of mathematics in economic analysis, and to equalization of the marginal utility of income as a principle of just taxation brought Irving Fisher and Ragnar Frisch to attempt to measure the marginal utility of income and led them to collaborate in forming the Econometric Society and sponsoring the establishment of the Cowles Commission, institutions advancing economic theory in connection to mathematics and statistics, and led Frisch to pioneer an axiomatic approach to utility and microeconomic theory.
In October 1929, the Dutch electronics firm Philips approached John Maynatd Keynes to write confidential reports on the state of the British and world economies, which he did from January 1930 to November 1934, at first monthly and then quarterly. These substantial reports (Keynes’s November 1931 report was twelve typed pages) show Keynes narrating the Great Depression in real time, as the world went through the US slowdown after the Wall Street crash, the Credit-Anstalt collapse in Austria, the German banking crisis (summer 1931), Britain’s departure from the gold exchange standard in August and September 1931, the US banking crisis leading to the Bank Holiday of March 1933, the London Economic Conference of 1933, and the coming of the New Deal. This series of reports has not been discussed in the literature, though the reports and surrounding correspondence are in the Chadwyck-Healey microfilm edition of the Keynes Papers. We examine Keynes’s account of the unfolding events of the early 1930s, his insistence that the crisis would be more severe and long-lasting than most observers predicted, and his changing position on whether monetary policy would be sufficient to promote recovery and relate his reading of contemporary events to his theoretical development.
Kenneth Arrow’s Social Choice and Individual Values (Cowles Monograph No. 12, 1951), a work that established the field of social choice and set the limits for what public economic theory could hope to achieve, was formulated at the Cowles Commission at the University of Chicago from 1947 to 1949 (and during the summer of 1948 at the RAND Corporation) in a context in which concern with using economic theory to guide the economy was intense. During the period just before he shared in developing the Arrow-Debreu-McKenzie proof of existence of general equilibrium, Arrow moved through a series of papers to prove the non-existence of a social welfare function. The context of Arrow’s non-existence proof for aggregation of individual preferences into social welfare function and to Arrow’s shift from trying to prove a possibility theorem for social welfare to proving an impossibility theorem has been confused by a reprinted and influential reminiscence in which Arrow mis-remembered when he had spent a summer at RAND and when he had presented his impossibility theorem to the Econometric Society.