Imperfect Knowledge

The financial sector can support growth but it can also cause crisis. The present crisis has exposedgaps in economists’ understanding of this dual potential.

In the seemingly never-ending aftermath to the economic crisis that began in 2007, there is little disagreement that financial markets are characterized by instability rather than stability.

Many feel that due to its size and scale the financial system has become a burden on society rather than a servant to it. What are the key elements of a productive financial sector?

Taking a long‐run view from economic history, I make three points about instability in financial markets. First, I argue that economic historians have a relatively good understanding of the proximate causes of financial crises.

What creates instability in financial markets? How does the weight of debt, the structure of expectations, or radical uncertainty contribute to instability?

In modern economies, individuals and companies engage in innovative activities, discovering new ways to use existing physical and human capital, and new technologies in which to invest. The institutional and broader social context within which these activities take place also changes in novel ways.

The economics profession stands on the fragile foundation of presuppositions adopted by professional agreement rather than as a result of empirical observation.

The human brain relies on three devices for its decisions: emotion controls; addictive learning; and intellectual processing. Understanding the conditions under which the three devices are engaged is essential for conscious decision-making.

George Soros, Axel Leijonhufvud and Perry Mehrling in Berlin, Germany (2012).