Grip on Complexity and Uncertainty

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Transcript Grip on Complexity and Uncertainty

Grip on Complexity and
16th January 2015
Lex Hoogduin
University of Groningen, Duisenberg School of Finance
and GloComNet
• Complexity of the economy and uncertainty of the
future should be taken into account to improve
(understanding of) supervision/governance of the
economy/financial sector
• Requires a different paradigm from current
mainstream economics
• Requires different methods; leads to different pretence
for economics; leads to different way of conducting
policy/supervision and to different policies
• 1. Replacing two core assumptions of
mainstream economics
• 2. Broad outline of the complexity and
uncertainty paradigm
• 3. Grip on complexity: a research agenda for
the financial system
1.Two core assumptions of the
mainstream (1)
• A. The assumed knowledge/information/data
available to economic agents
• Distinction between risk and uncertainty (cf.
Keynes 1921 and Knight 1921)
• Risk: all possible outcomes of a decision can
be known and listed
1.Two core assumptions of the
mainstream (2)
• Probability calculus can be applied and has a
solid foundation
• Mainstream economics: economic agents face
a risky future
• This concept underlies: modern mainstream
finance (Black/Scholes, CAPM,EMH, etc)
1.Two core assumptions of the
mainstream (3)
• Modern risk management (VAR, ES, etc)
• Arrow/Debreu model, DSGE model, RBC
• The use of rational expectations (RE)
• Basel III framework and supervisory view
1.Two core assumptions of the
mainstream (4)
• But: in making economic decisions it is logically
impossible to list all potential outcomes
• Logical argument: economic agents cannot know
now what they will discover/learn in the future
(see also Popper)
• Still, discoveries/learning in the future may
impact the outcomes of decisions taken now
1.Two core assumptions of the
mainstream (5)
• Therefore, not all potential outcomes can be listed
• In addition: consequences of decisions by an economic
agent may depend on what many, even unknown,
other agents will decide, based on their partly private
information and knowledge
• It is impossible for an agent to collect and process all
this information, to use it in his own decisions, while
taking into account how other agents will respond to
that, his response to it, and so on
1.Two core assumptions of the
mainstream (6)
• Therefore, the future is not risky, but (fundamentally)
• The future is unprestatable (cf. Kauffman)
• Economic decisions cannot be seen as computable
optimising problems
• In a risky future: money, finance, credit, financial
capital and debt play no causal role in the real
1.Two core assumptions of the
mainstream (7)
No financial cycles and crises
Liquidity has no role to play
No bankruptcies
No competition
No innovations
No role for laws, norms, conventions and
1.Two core assumptions of the
mainstream (8)
• B. The assumption about the distribution of
knowledge and information among agents and
the role of their interaction in explaining the
outcome of the economic process
• There is a great dispersion of knowledge and
information among economic agents
• The economic and financial system consist of
heterogenous agents who interact pursuing their
own objectives
1.Two core assumptions of the
mainstream (9)
• This point was early and thoroughly made by Hayek (CW
2014, forthcoming)
• Impossible to collect all knowledge/information/data
present in the economy at one central point
• Since 1980s development of complexity science covering
complex systems in many fields (Santa Fe Institute)
• In mainstream economics: little heterogeneity
(representative agents)
1.Two core assumptions of the
mainstream (10)
• Interconnectedness and structure of the
network of the economic/financial system are
no determinants of economic outcomes
2.Outline of the Uncertainty and
Complexity paradigm (1)
• Prediction of the future is difficult, if not impossible
• Patterns within organized complexity provide language and
basis for understanding the economic and financial process
• Emergent behaviour, e.g. competition, innovation, financial
cycles and crises, growth, inflation and deflation
• Causality running not only from micro to macro, but both
2.Outline of the Uncertainty and
Complexity paradigm (2)
• Power laws rather than normal distributions; clustering;
cumulative change; positive feedback mechanisms; Black
• Sudden transitions, tipping points, non-linear dynamics
• Evolutionary development: future is not there to be
discovered, but is shaped by/emerges from the
(inter)actions of agents on the basis of their expectations of
that future and their confidence therein
• Central role of entrepreneurship and leadership in that
2.Outline of the Uncertainty and
Complexity paradigm (3)
• The future cannot be predicted, but it can be imagined (cf.
Shackle). Expectations are drivers of economic
developments, rather than passive or an equilibrium
• All the phenomena that do not have a proper role in a risky
world fall into place in a world where agents face
• Liquidity in particular can be seen as a means to keep
options open in a world where surprises can and will always
happen and where there are unintended consequences of
actions and policies
2.Outline of the Uncertainty and
Complexity paradigm (4)
• Pretence: To understand, rather than to
• To navigate and adapt rather than to control
• Deal with uncertainty and complexity rather
than trying to reduce it
• Acting in the face of complexity and
• Piecemeal social engineering rather than
grand designs
2.Outline of the Uncertainty and
Complexity paradigm (5)
• Emphasis in policy on creating the right conditions for desired
outcomes to emerge rather than on bringing about those
outcomes; role of norms in economic policy in that context
• Order rather than equilibrium
• Focus on ever evolving order (process) rather than end-point
• Focus on diversity rather than diversification
• Importance of resilience; slack/buffers;redundancies
• Tools (multidisciplinary and pluralistic):
• Decision-making under complexity and uncertainty (Post-Keynesian,
(Neo-) Austrian and psychological theory); online course at, starting 19th January
2.Outline of the Uncertainty and
Complexity paradigm (6)
• Graph/network theory
• Agent-based modeling, including cellular
• Gaming
• Non-linear dynamics
• Experiments
• Behavioural economics
• Historical method/path dependency/locking-in
• Institutional economics
3.Research agenda Grip on
• Research project under the title “Grip on
• One of the sub projects: how to deal with/get
grip on the complex financial sector?
• Would like to develop this into an
international research hub on this issue
3.Research agenda Grip on Complexity
• There is potentially a very long and fruitful
research agenda
• Both theoretical/conceptual and immediately
policy relevant issues can be addressed
• What could be on the agenda? A nonexhaustive list. Topics may be added and
deleted. Choices have to be made
3.Research agenda Grip on
• Role of capital and liquidity
• Data strategy for supervisors
• Impact of Vickers/Volcker/Liikaanen in a network
• Central clearing implications in a network model
• Understanding financialisation and its impact (the
Great Finanical Expansion of the past decades)
• Impact of separation of retail and investment
3.Research agenda Grip on Complexity
• Impact of limiting the size of banks
• Impact and design of resolution regimes
• The supervisory strategy: simplicity and norms
in a complex system?
• Competition, innovation and growth
• Shadow banking
• The evolution of a bank or market based
financial system
3.Research agenda Grip on Complexity
• The role of diversity vs diversification
• The impact of quantitative risk management
on the development of the financial system
• The impact of modern portfolio theory and
asset managers on the development of the
financial system
• Design of stress tests
• Macroprudential policy, monetary policy and
their interaction
• Also setting up a network (GloComNet) for
research, education and consultancy with respect
to complexity and uncertainty
• Intention to use GloComNet platform as a
“vehicle” for the research project “Grip on