Federal Reserve Bank Chairman Ben Bernanke spoke at a conference co-sponsored by the Center for Economic Policy Studies and the Bendheim Center for Finance, Princeton University on September 25th. A portion of that speech entitled Implications of the Financial Crisis for Economics, follows:
Economics and Economic Research in the Wake of the Crisis
Economic principles and research have been central to understanding and reacting to the crisis. That said, the crisis and its lead up also challenged some important economic principles and research agendas. I will briefly indicate some areas that, I believe, would benefit from more attention from the economics profession.
Most fundamentally, and perhaps most challenging for researchers, the crisis should motivate economists to think further about their modeling of human behavior. Most economic researchers continue to work within the classical paradigm that assumes rational, self-interested behavior and the maximization of “expected utility” — a framework based on a formal description of risky situations and a theory of individual choice that has been very useful through its integration of economics, statistics, and decision theory. An important assumption of that framework is that, in making decisions under uncertainty, economic agents can assign meaningful probabilities to alternative outcomes. However, during the worst phase of the financial crisis, many economic actors — including investors, employers, and consumers — metaphorically threw up their hands and admitted that, given the extreme and, in some ways, unprecedented nature of the crisis, they did not know what they did not know. Or, as Donald Rumsfeld might have put it, there were too many “unknown unknowns.” The profound uncertainty associated with the “unknown unknowns” during the crisis resulted in panicky selling by investors, sharp cuts in payrolls by employers, and significant increases in households’ precautionary saving.
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A major exhibition featuring the works of the foremost American portrait painter of the late 19th-century, John Singer Sargent, is still on view at the