Lars Peter Hansen on Risk, Ambiguity, and Measurement
Jun 30, 2014
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Lars Peter Hansen, a distinguished economist from the University of Chicago and Nobel Laureate, engages in a deep dive into the nuances of economic modeling and risk assessment. He discusses the limitations and benefits of quantitative methods in understanding financial systems, especially after the 2008 crisis. The conversation highlights the psychological biases affecting risk evaluation, the need for balanced data and theory in economics, and the implications of fiscal policy in crisis management. Hansen advocates for strategic infrastructure investments and critiques simplistic views on government spending.
Economic models are valuable tools for policy guidance, but their inherent limitations necessitate cautious application to avoid oversimplifying complex realities.
Quantifying systemic financial risk remains challenging post-2008 crisis, highlighting the need for clearer evidence and definitions to inform regulatory policies.
The distinction between quantifiable risk and ambiguity is crucial for effective economic modeling, guiding more robust policy decisions amidst uncertainty.
Deep dives
The Significance of Quantitative Economics
Quantitative analysis is essential in economics as it allows for model building that guides policy decisions, connecting empirical evidence with economic theory. However, the speaker highlights the inherent limitations and inaccuracies of models, noting that they can oversimplify complex realities. The acknowledgment that 'models are always wrong' emphasizes the necessity of being cautious in their application, particularly regarding systemic risk in the financial sector. This underscores the challenge of relying too heavily on quantitative projections without recognizing their constraints.
Understanding Systemic Risk
Systemic risk, especially highlighted after the 2008 financial crisis, remains an area where quantification efforts are in their infancy. Despite becoming a buzzword in financial regulation, the precise definition and measurement of systemic risk are still elusive, making it difficult to determine the effectiveness of policies implemented post-crisis. Much like the complexities of identifying phenomena such as 'Bigfoot', the concept of systemic risk can be known intuitively but is challenging to quantify rigorously. There is a pressing need for clearer evidence to support claims about the necessity and impact of bailouts and interventions during financial instability.
The Role of Models and Policy Design
Models play a pivotal role in economic policy formation, but historical skepticism, particularly from figures like Friedrich Hayek, raises questions about their reliability. While models can offer structured insights, overconfidence in their accuracy can lead to misguided policy actions. The speaker draws parallels with historical examples where reliance on incomplete models resulted in harmful outcomes, advocating for a balanced approach that acknowledges both the usefulness and the limitations of modeling. This approach suggests a need for a simpler, more effective policy design that can adapt to the complexities of economic conditions.
Addressing Risks and Uncertainties in Economics
A critical distinction is made between risk, which can be quantified, and ambiguity, which represents the challenges of modeling different economic scenarios. The speaker delineates how uncertainty arises in economic models due to incomplete knowledge of parameters or the fundamental flaws in these models. By understanding these distinctions, economists can approach policy design more effectively, recognizing what aspect of uncertainty may significantly influence their outcomes. This understanding is vital for developing robust decisions in face of economic unpredictability.
Fad Dynamics in Economic Research
Economic research is often susceptible to fads driven by the pursuit of trendy topics rather than sustained scholarly work. The speaker notes that this can lead to premature conclusions without thorough investigation, as researchers chase the latest popular subject for publication. It is essential that economists focus on enduring questions, especially those that connect financial markets to macroeconomic stability, instead of following fleeting trends. By nurturing a more systematic approach to research that prioritizes lasting impact, the field can enhance its relevance and effectiveness.
Lars Peter Hansen of the University of Chicago and Nobel Laureate in economics, talks to EconTalk host Russ Roberts about the power and limits of economic models and quantitative methods. Hanson defends the value of models while recognizing their limitations. The two also discuss quantifying systemic financial risk, how our understanding of financial markets has changed, the nature of risk, and areas of economics that Hanson believes are ripe for further research.
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