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Skip to 0 minutes and 11 seconds This week, we will think about financial crisis. A financial crisis happens when banks and other financial companies suddenly cannot pay their bills anymore. And this means they also cannot give loans to other parts of the economy anymore. And because everyone depends on banks, a financial crisis can quickly become an economic crisis. Financial crises can start very small, maybe even with only one bank, like Lehman in 2008. But they can spread to a global crisis. It all depends on the connections between banks and traders in financial products and the rest of the economy.

Skip to 0 minutes and 55 seconds So we already see that financial markets are complex systems, in the sense that the behaviour of the whole market cannot be understood from the behaviour of individuals on the markets. It’s the interaction between traders, investors, and other market participants which shapes the market and which makes it so unpredictable, often. So in addition to complexity, there is also a lot of uncertainty on financial markets. Now every now and then, this uncertainty erupts into a financial crisis. This is always unexpected, but there are patterns that we can study to understand how it happens. And this week, you will learn about those patterns.

Skip to 1 minute and 47 seconds But there is no theory which tells you how and when a financial crisis will happen, like we have natural laws that tell us where a planet will be five days from now.

Skip to 2 minutes and 0 seconds Let’s first think a bit about why it is so difficult for economists to built theories of financial crisis. Remember all you’ve learned about uncertainty until now. The world is a complex and uncertain place. Well, the opposite way of thinking is determinism. And it is very popular in economics. Most economists, in fact, use models where there is no uncertainty at all. Therefore, a crisis is not supposed to happen in these model worlds. And that is one of the reasons why most academic economists were completely taken by surprise when the 2008 financial crisis happened. But that is not the only examples of determinism. Because on the other extreme, there are people who are always predicting that capitalism will collapse.

Skip to 2 minutes and 57 seconds Reality is that’s contrary to what economic models tell us, crisis do happen quite often. But also, contrary to what doomsayers tell us, capitalism has not collapsed. Both these kinds of predictions presume that everything is already determined, and therefore, if we’re only clever enough, we will be able to figure out the future. They presume we do not make and change our future all the time which, of course, we do. So let’s call this the deterministic view. Deterministic predictions of stability or crisis may sometimes seem to be right. Think of all the people who said, I told you so, after the 2008 crisis happened.

Skip to 3 minutes and 47 seconds And before that, when there was stability, many economists boasted they had ensured economic stability forever by their own wise policies and just as their models presumed. Now economists, who always say the world is stable and predictable, seem to be right in some years. And doomsayers, who always say there’s going to be a crisis, seem to be right in other years. But really, this is an example of what we could call the stopped clock syndrome. These people are just saying the same thing all the time, like a stopped clock. Now a stopped clock is correct twice in every 24 hours. But how helpful is that, really?

Economic determinism

This first activity is about financial crises. Why didn’t economists see the 2008 financial and economic crisis coming? This video explains a problem with economic models: determinism. What is determinism and how does it play a role in economic models?

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Decision Making in a Complex and Uncertain World

University of Groningen

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