Thursday, September 2, 2010

The Economy : Uncertainty as the Way of the Future

Posted by Will Moredock on Thu, Sep 2, 2010 at 11:20 AM

Now that the war in Iraq is "over," it's time to deal with our economic woes. But don't get too optimistic. According to this Reuter's commentary, there are too many uncertain and unknowable factors to our modern economy and to modern technology to make investors or CEOs comfortable. If this is correct, we are in for a longer and rougher ride than our leaders have led us to believe. And the GOPers will be as powerless as the Democrats to fix it.

http://blogs.reuters.com/great-debate/2010/08/31/the-knightian-dog-ate-my-recovery/


Remember when business and economic leaders droned on about “100-year storms,” 2008’s get-out-of-jail free card for people who missed the housing bubble?

This was the whole idea that there was no way that people could be held accountable for the crisis because the notion of there being a problem with continual double-digit house price growth and sky-high leverage was just so darned unlikely.

Well, it looks like we have the 2010 version of how the dog ate their homework again and this time it is called “Knightian uncertainty.”

Over to European Central Bank chief Jean-Claude Trichet, who in a weekend speech at the Federal Reserve’s economic conference in Jackson Hole, Wyoming more or less said there is a biggish chance that he and his peers have no idea what is going on or what will happen next.

“Today, central bankers have to take decisions in an environment marked by a degree of uncertainty in the economic and financial sphere that seems to me largely unprecedented. … The acceleration of major advances in science and technology (not only information technology), the ensuing structural transformations of our economies, the ever-growing complexity of global finance and the overall process of globalisation are itself creating a multidimensional acceleration of change,” Trichet said.

“These phenomena contribute not only to a wider degree of uncertainty in underlying probability distributions, including fat tails. They also entail a much more significant element of Knightian uncertainty — that is, the type of uncertainty in which there is no underlying probability distribution.”

So, what is this Knightian uncertainty and why is it causing the price of our shares and houses to go down? Named after University of Chicago economist Frank Knight, it is the idea that there is a distinction between risks, which you can assign probabilities to, and uncertainties, which you just can’t fathom.

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