Posted by: Nicholas Davis | May 24, 2009

Fed Chairman Ben Bernanke on managing uncertainty

Helicopter Ben made some very interesting remarks on the unpredictability of life in general and the economy in particular during the commencement address for Boston College School of Law yesterday.

Bernanke starts by saying:

As an economist and policymaker, I have plenty of experience in trying to foretell the future, because policy decisions inevitably involve projections of how alternative policy choices will influence the future course of the economy. The Federal Reserve, therefore, devotes substantial resources to economic forecasting. Likewise, individual investors and businesses have strong financial incentives to try to anticipate how the economy will evolve. With so much at stake, you will not be surprised to know that, over the years, many very smart people have applied the most sophisticated statistical and modeling tools available to try to better divine the economic future. But the results, unfortunately, have more often than not been underwhelming.”

In other words, even with all the resources of both the government and the private sector, forecasting has failed to give insight more often than it has. It’s bout time that a senior economic policymaker recognized what Spyros Makridakis proved back in the 1970s.

Ben goes on to say:

Like weather forecasters, economic forecasters must deal with a system that is extraordinarily complex, that is subject to random shocks, and about which our data and understanding will always be imperfect. In some ways, predicting the economy is even more difficult than forecasting the weather, because an economy is not made up of molecules whose behavior is subject to the laws of physics, but rather of human beings who are themselves thinking about the future and whose behavior may be influenced by the forecasts that they or others make. To be sure, historical relationships and regularities can help economists, as well as weather forecasters, gain some insight into the future, but these must be used with considerable caution and healthy skepticism.”

Two important things here – first, there is a clear admission of complexity that is exacerbated by behavioural elements on the part of agents in the economy. This should give behavioural economists cause for celebration. But second, it seems that Bernanke is making these remarks still within the assumptions of the efficient market hypothesis, by saying that the system “is subject to random shocks”. To me this implies that external shocks (and perhaps the randomness of asset movements) are the prime cause of instability, rather than endogenous forces a la Minsky et al.

There’s a nod to the illusion of control, which Spyros and Anil Gaba will be glad about:

In planning our own individual lives, we all have a strong psychological need to believe that we can control, or at least anticipate, much of what will happen to us. But the social and physical environments in which we live, and indeed, we ourselves, are complex systems, if you will, subject to diverse and unforeseen influences… Life is much less predictable than we would wish. As John Lennon once said, ‘Life is what happens to you while you are busy making other plans’.”

And Ben even provides philosophical advice in line with Dance with Chance in response to this challenge:

Our lack of control over what happens to us might be grounds for an attitude of resignation or fatalism, but I would urge you to take a very different lesson. You may have limited control over the challenges and opportunities you will face, or the good fortune and trials that you will experience. You have considerably more control, however, over how well prepared and open you are, personally and professionally, to make the most of the opportunities that life provides you. Any time that you challenge yourself to undertake something worthwhile but difficult, a little out of your comfort zone–or any time that you put yourself in a position that challenges your preconceived sense of your own limits–you increase your capacity to make the most of the unexpected opportunities with which you will inevitably be presented. Or, to borrow another aphorism, this one from Louis Pasteur: ‘Chance favors the prepared mind.’”

Bernanke goes on to relate how his life of accidents, opportunities and serendipitous moments has shaped his career before turning to the relevance of these ideas to policymaking:

Although I never could have prepared in advance for the specific events of the past 21 months, I believe that my efforts throughout my life to expand my horizons and to keep a broad perspective–for example, to study and write about economic and financial history, as well as more conventional topics in macroeconomics and monetary economics–have helped me better meet the challenges that have come my way. At the same time, because I appreciate the role of chance and contingency in human events, I try to be appropriately realistic about my own capabilities. I know there is much that I don’t know. I consequently try to be attentive to all points of view, to work collaboratively, and to involve as many smart people in policy decisions as possible. Fortunately, my colleagues and the staff at the Federal Reserve are outstanding. And indeed, many of them have demonstrated their own breadth and flexibility, moving well beyond their previous training and experience to tackle a wide range of novel and daunting issues, usually with great success.”

Great stuff – he advocates reading beyond narrow fields, appreciating uncertainty, accepting personal fallibility and recognizing the importance of collaboration and flexibility. Can it get better? Yep.

Law is like economics in that, although it has its own esoterica known only to initiates, it is at bottom a craft whose value lies primarily in its practical application… In law school you have honed your skills in reasoning, reading, and writing. Many of you have work experience or bring backgrounds to bear ranging from history to political science to the humanities to science. There will always be a need for people with your abilities and talents.”

Music to my ears, Ben. Not only does he implicitly reject the ‘science’ of economics by likening it to the ‘craft’ of law, but he goes on to validate my choice of first degree, law. Nice

Any final words of advice, Chairman?

…stay optimistic. Things usually have a way of working out. My second piece of advice is to be flexible, even adventurous as you begin your careers. As I have tried to illustrate today, you are much less able than you think to foresee how your life, both professional and personal, will play out. The world changes too fast, and too many accidents and unpredictable events occur. It will pay, therefore, to be creative and open-minded as you search for and consider professional opportunities. Look most carefully at those options that will give you a chance to learn new things, explore new areas, and grow as a person. Think of every job as a potential investment in yourself. Will it prepare your mind for the opportunities that chance will provide?”

I don’t know about you, but I think this is pretty cool career advice. While it doesn’t help with figuring out what exactly floats your boat in order to choose between opportunities, at least it gives some pretty clear guidelines for managing uncertainty: optimism (embracing opportunities), flexibility (be ready and able to adapt), creativity (be generative and transformational, look beyond the surface problem for alternative points of leverage), and open-mindedness (talk to strange people, read different books and look for unconventional solutions). Finally, when making decisions, consider how what you do is investing in yourself and preparing your mind for the future. Thanks Ben.


  1. Hi Nick, interesting post- my thoughts turn to the statement that law’s value lies in its practical application: I’m now a project manager working on what are classified as complex system-of-system programs, where uncertainty is inherent. Unfortunately, most senior lawyers I encounter (both public and private sector) have neither the legal toolset nor mindset to help support emergence- Ben talks to innovation, but our bastions of culture and knowledge (whether academia, or professions) do not support anti-positivism, and in fact reward those that work within the relevant paradigms. Furthermore, I would argue that an adversarial legal system is fundamentally risk-averse, and as such is unable to accommodate uncertainty (just think back to your principles of contract)- the lawyers I meet are more into risk-dumping and pretending that the world has artificial certainty, rather than commercially and flexibly alllocating risk in a manner that adds real value to complex programs. But appart from that, I agree with everything 🙂

  2. Pete,

    Thanks for the comment – I’d love to know more about what you’re doing now!

    You highlight a couple of interesting points there – that lawyers aren’t equipped to cope with emergence, that our institutions don’t reward or support antipositivism, and the legal system is risk-averse.

    Having spent some time as a solicitor, I tend to agree with you in some respects re emergence on the micro-level: most lawyers are “takers” of the law, and our legal training (as I recall) wasn’t particularly aimed towards the uncertainty side of legal systems. But I’ve come across quite a few barristers and senior solicitors in litigation who are keen to make law through landmark rulings, and push the emergence of legal principles and social shifts in order to win a case. And perhaps things are particularly different at a macro level. From one perspective, the combination of a common law system and a legislature give rise to a natural evolution of law, with a nice reflexivity between society, parliament and the bench.

    Re antipositivism, to be honest I’m not really up on the latest thinking in jurisprudence, but I do remember we were taught a lot of Dworkin… is he persona non grata now, or did I just miss that 10 years ago?

    Finally, the legal system is indeed risk averse and scared of uncertainty. In fact public, positive law can be seen as aiming at reducing uncertainty in all judicial matters – and even judges get sentencing guidelines, while lawyers do love contracts (I might write one tonight, in fact!). But the nice thing about being trained in law is that it teaches you to manage uncertainty in a particular way – by insuring against it however possible through appropriate channels. This is fine on the micro-level (I read the fine print etc etc), but you’re right that in other areas lawyers are just shifting risk around. The problem with both legal and commercial risk allocation is that unless you understand exactly how shifting the risk affects the system as a whole, you might end up being caught up on the sinking ship nevertheless.

    All of which should make us think twice about what we’re doing when Australian lawyers, regulators and bankers get together to re-write product disclosure agreements that no-one reads.

  3. […] but that is going to do nothing to get housing supply off the market.  I know President Obama and Ben Bernanke think that housing will lead us out of this troubled time, but we truly need to create jobs to […]

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