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Nobel Prize in Economics winner Lars Peter Hansen on imperfect models

David Brancaccio Dec 10, 2013
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This morning in Stockholm, Sweden, three American men will be awarded the Nobel Prize in Economics. Yale’s Robert Shiller and the University of Chicago’s Eugene Fama and Lars Peter Hansen are being recognized for their at times conflicting research into how financial markets work.

Before he departed, Marketplace Morning Report host David Brancaccio spoke with Lars Peter Hansen. Click the audio player above to listen to their interview.

DB: Your work embraces the imperfection of economic models, but still allows you to get work done?

LPH: I view the work I’ve done related to statistics and economics as roughly speaking, how to do something without having to do everything. So economic models — how any model by definition isn’t right. When someone just says, ‘Oh, your model is wrong.’ That’s not much of an insight. What you want to know is, is wrong in important ways or wrong in ways that are less relevant? And you want to know what does the data really say about the model?

DB: One example that comes to mind is we know a lot about climate change, but there’s also a lot we don’t know. What do you think your way of thinking about imperfect models would mean for making good decisions about an issue like that?

LPH: So that’s a fascinating question. And this shows up not only in connections to economics and the climate, it also shows up in financial oversight and regulation. Early on, in discussions of financial oversight, people would say, ‘Well, this is a very complicated problem, therefore it requires a complicated solution.’ And at that step, I would say, ‘Well, wait a minute. Just because it’s a complicated problem doesn’t mean the best course of action immediately is one that’s complicated.’ Because, you know, behind complexity you can slip indiscretion, you can slip in counterproductive measures that overstate our knowledge and the like. And an advantage of a more simpler approach is transparency as well.

DB: It would be nice, for instance, if you could eventually offer some guidance of which of those institutions are, in fact, too big to fail or more likely to fail.

LPH: Part of what we have to do, or part of what remains a challenge, is we have to be not scared of letting institutions fail. You know, extended bankruptcy from big financial institutions would just be a disaster typically, because this could have very big consequences. But we need to figure out better ways to get resolution when financial institutions are struggling in ways that aren’t socially so costly to us.

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