Armin Haas

THE FINANCIAL CRISIS AND THE SYSTEMIC FAILURE OF THE ECONOMICS PROFESSION

ABSTRACT Economists not only failed to anticipate the financial crisis; they may have contributed to it—with risk and derivatives models that, through spurious precision and untested theoretical assumptions, encouraged policy makers and market participants to see more stability and risk sharing than was actually present. Moreover, once the crisis occurred, it was met with incomprehension by most economists because of models that, on the one hand, downplay the possibility that economic actors may exhibit highly interactive behavior; and, on the other, assume that any homogeneity will involve economic actors sharing the economist’s own putatively correct model of the economy, so that error can stem only from an exogenous shock. The financial crisis presents both an ethical and an intellectual challenge to economics, and an opportunity to reform its study by grounding it more solidly in reality.

The financial crisis and the systemic failure of academic economics

The economics profession appears to have been unaware of the long build-up to the current worldwide financial crisis and to have significantly underestimated its dimensions once it started to unfold. In our view, this lack of understanding is due to a misallocation of research efforts in economics. We trace the deeper roots of this failure to the professions focus on models that, by design, disregard key elements driving outcomes in real-world markets. The economics profession has failed in communicating the limitations, weaknesses, and even dangers of its preferred models to the public. This state of affairs makes clear the need for a major reorientation of focus in the research economists undertake, as well as for the establishment of an ethical code that would ask economists to understand and communicate the limitations and potential misuses of their models.

Climate change and modelling of extreme temperatures in Switzerland

This study models maximum temperatures in Switzerland monitored in twelve locations using the generalised extreme value (GEV) distribution. The parameters of the GEV distribution are determined within a Bayesian framework. We find that the parameters of the underlying distribution underwent a substantial change in the beginning of the 1980s. This change is characterised by an increase both in the level and the variability. We assess the likelihood of the heat wave of the summer 2003 using the fitted GEV distribution by accounting for the presence of a structural break. The estimation results do suggest that the heat wave of 2003 is not that statistically improbable if an appropriate methodology is used for dealing with nonstationarity.

A method for computing the fraction of attributable risk related to climate damages

The recent decision of the U.S. Supreme Court on the regulation of CO2 emissions from new motor vehicles shows the need for a robust methodology to evaluate the fraction of attributable risk from such emissions. The methodology must enable decisionmakers to reach practically relevant conclusions on the basis of expert assessments the decisionmakers see as an expression of research in progress, rather than as knowledge consolidated beyond any reasonable doubt. This article presents such a methodology and demonstrates its use for the Alpine heat wave of 2003. In a Bayesian setting, different expert assessments on temperature trends and volatility can be formalized as probability distributions, with initial weights (priors) attached to them. By Bayesian learning, these weights can be adjusted in the light of data. The fraction of heat wave risk attributable to anthropogenic climate change can then be computed from the posterior distribution. We show that very different priors consistently lead to the result that anthropogenic climate change has contributed more than 90% to the probability of the Alpine summer heat wave in 2003. The present method can be extended to a wide range of applications where conclusions must be drawn from divergent assessments under uncertainty.

Keynes and the international monetary system: Time for a tabular standard?

Abstract This paper discusses proposals for tabular standards in the late nineteenth and early twentieth centuries. In particular, we focus on Keynes’ proposal for an international tabular standard (ITS) as the gold standard unravelled in the 1930s. The paper explains the origins of Keynes’ ITS proposal which pegged the value of an international reserve to a broad index of primary commodities, weighted in terms of their value in world production. We argue that the ITS should be viewed as an important and enduring component of Keynes’ ideal long-run vision for anchoring the international monetary system, even post-Bretton Woods.

Things are different today: the challenge of global systemic risks

Abstract While most OECD countries have been rather successful in reducing risks to human lives, health, and the quality of the environment, the record for new global risks such as climate change, pandemics, financial breakdowns, and social inequality is much less convincing. This is the challenge of systemic risks. Since the global financial crisis, it has received rapidly growing attention. However, considerable conceptual confusion mars research on and practical responses to this challenge. We undertake an effort of conceptual clarification, starting with the paradigmatic example of the financial crisis. This leads to a view of global systems as involving an interplay between micro- and macrodynamics internal to the system, with the system simultaneously interacting with its environment. Such dynamics typically show periods of stability, punctuated by situations opening up several possible futures. Alternative global futures, like other prospects, constitute risks for an agent if she considers some of these futures as less desirable than others. Agents may have lexicographic preferences over futures they would like to avoid, so as to consider some futures as just undesirable, but others as catastrophic. If an agent expects some of the relevant futures at a bifurcation point of a global system to be catastrophic in this sense, they are faced with a systemic risk.

Transitions Into and Out of a Crisis Mode of Socio-ecological Systems

The concept of entry into and exit out of a crisis mode of socio-ecological systems is a powerful tool for dealing with social learning in the face of large-scale risks. This concept can be used both for descriptive and normative research. We briefly sketch the concept using the example of the European heat wave in 2003.

The Economics of Economists: The financial crisis and the systemic failure of academic economics

The economics profession appears to have been unaware of the long build-up to the current worldwide financial crisis and to have significantly underestimated its dimensions once it started to unfold. In our view, this lack of understanding is due to a misallocation of research efforts in economics. We trace the deeper roots of this failure to the profession’s focus on models that, by design, disregard key elements driving outcomes in real-world markets. The economics profession has failed in communicating the limitations, weaknesses, and even dangers of its preferred models to the public. This state of affairs makes clear the need for a major reorientation of focus in the research economists undertake, as well as for the establishment of an ethical code that would ask economists to understand and communicate the limitations and potential misuses of their models.