What event of the past ten years has had the greatest influence on your analysis of risk?

I think the biggest issue, certainly when I think about risk, has mainly been the challenges of terrorism that we as a service faced after 9/11 and right through to the present day. Ensuring that these were managed appropriately, while avoiding giving too much power to the state, but also explaining it in a way that non-experts can understand was a really big challenge.

What can this teach us?

I think you have to recognise terrorism as a long term problem. We can manage it, we can reduce it, but it can't be entirely avoided. This is a political issue that needs to be addressed. The other thing is increasing public understanding of what this means, and the way in which we challenge and contain it as a society.

What lessons have not been learned and what has been neglected?

I think in terms of counter-terrorism one of the lessons has been that the intelligence security authorities need to be much more open to discussing these problems, certainly in the UK, because they are societal problems and not just narrow, national security problems. And I think that good communication of risk is true not just in government but also right across the commercial sector as well.

What event of the past ten years has had the greatest influence on your analysis of risk?

The biggest influence was certainly the financial crisis. It revealed the extent to which automatic mechanisms, chain reactions and algorithm-based processes that we are barely able to control now exist in the global economy. Let me tell you about something I experienced myself on the day that Lehman Brothers collapsed in New York. A colleague and I were there by chance, carrying out a study on bankers and brokers. The initial reaction was to switch off the computers and not answer any calls from Washington. This shows how unprepared people were for all the things that began happening. It was an extreme situation and made a huge impression on me.

What can this teach us?

The lesson of course is that particularly the G20 – i.e. the group of the world’s 20 leading industrialised countries, which acts as a kind of informal world government – needs to take effective action to regulate the financial sector. I’m not sure that this will succeed. I believe the opposition is very strong. Automatic mechanisms are extremely advanced. This makes me doubt whether there is still a way of returning to an overarching supervisory authority that really can regulate the financial sector. My hope is that enlightened forces will be stirred in the financial sector itself and that these forces will think about investments focused on the common good and will be able to overcome the greediest forms of casino capitalism.

What lessons have not been learned and what has been neglected?

Many lessons haven’t been learned. On climate change, for example. We’ve known about climate change for more than 100 years. It’s been familiar to us since the mid-1960s, when the first measurements pointed in this direction. It’s been all too visible to us since the start of the millennium, yet so little is being done. Above all, governments are holding each other back. In the old industries, there are strong forces that block any shift towards effective climate protection. And the activities that have begun in civil societies are not strong enough to force politicians in government to step up their efforts. I’d hoped that we would learn our lesson before catastrophe struck. Now we’ll probably have to learn it as the catastrophe unfolds.

What event of the past ten years has had the greatest influence on your analysis of risk?

For me it's these big discontinuities. You have to go back a little bit further than 10 years but in the United States we had the Iraq War and then we had the financial crisis. In Europe you had the Euro crisis and the refugee crisis. Both of these in retrospect, I think, were predictable given the policy choices that had been made by the political authorities. But I think the way they played out and their consequences, you know, were very much surprising. And I think they are problems - they created problems that still have not been completely dealt with.

What are the lessons we can learn from this?

I think that the problem that has been created by these events is the rise of a global anti-elite populism. That's present in Europe with the rising number of anti-Europe, anti-immigrant, right wing parties; and with the election of Donald Trump in the United States; the Brexit vote in Britain. And I don't think that we're done with any of these developments. I think that we're going to have to figure out how to both deflect but also to some extent to becalm the anger that is driving the voters and has created these events.

What lessons have been learned and which have gone unheeded?

Well, it really depends: I think that in the United States, foreign policy mistakes that began with the Iraq invasion had to do with the overextension of American foreign policy. And now since Obama and I think continuing with Mr. Trump, there’s been the opposite reaction of withdrawing from international events. So, I think that creates its own set of problems because that global order really requires American leadership. I think in the case of the European Union there's been a vacuum at the heart of Europe. There are some major institutional changes that need to take place in order to manage future crises. I think immigration still remains a major source of unhappiness for many citizens in Europe. And that is an issue that's really also not been dealt with by anyone in Europe.

What event of the past ten years has had the greatest influence on your analysis of risk?

Well, thinking about other dimensions of risk - not just risk itself, but the persistence of risk. There are many dimensions to the ways in which we think about risk and what people might care about when it comes to risks: Do you care just about the risk? Do you care about its time structure? Do you only consider a risk on its own as something independent and continue to do that over time, or do you care about risk that persists? People have very different attitudes towards this, and what matters is what they do to protect themselves against such risks. They can choose very different approaches to this, and so the kind of portfolios they want can also be very different.

What are the lessons we can learn from this?

There are several lessons. It makes you think hard about what your attitude towards the persistence of risk is. And in the opinion of economists like Lars Hansen, this perspective offers a way of explaining the high excess returns earned by some fama-french portfolios as the compensation that a representative investor who dislikes persistence of risk requires to hold such a portfolio. These big risk premiums are to some extent a compensation for bearing a persistent risk.

What lessons have been learned and which have gone unheeded?

Good question. Economists since Keynes have been trying to figure out sensible and rigorous ways of distinguishing ‘risk’ from a profounder kind of ignorance that they call ‘uncertainty’. We have struggled to find an agreed workable definition of uncertainty that can be used in practical situations. But lots of progress has been made recently, especially by theorists. Now we are trying to apply their ideas to real problems in finance and monetary policy.

What event of the past ten years has had the greatest influence on your analysis of risk?

Obviously I look at risk mainly from a philosophical perspective. I find it extremely interesting to see how society has tried to deal with technological risks such as those involved in using nuclear energy. The debates surrounding this were sometimes highly emotional, but nevertheless led to a certain clarity about the situation, and in the end resulted in the German government essentially ending this technological risk in the wake of the Fukushima disaster. No other country in the world had taken the decision to phase out nuclear energy. It is a very bold strategy. And that was a very big influence on me as a physicist who had originally dealt at great length with issues surrounding energy.

What can this teach us?

One lesson is that you have to get the public involved as early as possible. The notion that we can delegate matters of risk to experts and that the wider population, who are all affected by the risk, are ultimately just supposed to trust those experts and accept their decisions, has been repeatedly proven wrong. It's not just about minimising risks but also about obtaining the consent of the people who are affected. Without the consent of the affected parties, every risk transfer, every increase in a risk for a person is ultimately unethical.

What lessons have been learned and which have gone unheeded?

The lesson from this debate surrounding the risks of nuclear energy is that an 'expertocracy' alone is not enough. Politics has become more attuned here. It is more willing to enter into these debates. At the same time, however, you can't help but notice that something which in the 1970s had played a major role, namely debates about energy scenarios, different perspectives in society, assessments of the impact of technology and visions of the future, has largely come to a standstill. This means we currently have no major debate about the different paths that the global economy could follow. And that is a cause for concern because, ultimately, the political sphere needs to decide the direction it wants to go in. And if this is not preceded by a process of clarification, then it will cause similar turmoil again.

What event of the past ten years has had the greatest influence on your analysis of risk?

Oh, I think the problems of 2008 and the mini recession – or whatever one wants to call it. They certainly changed my view of many things and they changed the views of most economists about what was going on. They made us aware that the usual way of thinking about things wasn’t really going to be acceptable going forward. More complicated things were going on in the world.

What can they teach us?

In terms of trying to model and understand what’s happening in the economy, I think they can teach us much more about institutional forces and institutional settings. And simple things that we used to not really pay a lot of attention to, for example regulation or accounting, have much more profound effects on what’s happening – particularly in the financial markets – than I would have thought was the case.

Which lessons have been learned and which have not?

I think the same problems are going to arise and we’ve done nothing really substantive to solve them. If you really want to do something substantive, the simplest solutions are often the best. And the simplest solution is to require that banks have more capital. And, in fact, if you go back historically, banks used to have a lot more capital. And they had a lot more capital at the very time when the industrial revolution was coming to fruition. To make it even more pressing: not only were they highly capitalised – if you were a holder of bank stocks you didn’t have limited liability, you had unlimited liability. I think people have lulled themselves into thinking that they’ve solved it when in reality they haven’t.

Which events had the greatest influence on your dealing with risks over the past ten years?

The big event of the last ten years has been the financial crisis. It started in the United States and spread to the whole world. It was a crisis related to speculative bubbles, most notably in the US housing market, but also in other countries. The collapse of home prices put millions of households under water and caused them to stop spending. How did we get a home price boom in all these different countries? The fact that it wasn’t just in one country suggests to me that it was something beyond just government policy. It was something in the minds of people. So it confirms for me the importance of understanding human psychology and incorporating these insights into the realm of finance.

What lessons will we learn from this?

For many people the financial crisis was an epiphany. They discovered that bubbles can happen. Speculative bubbles have occurred many times in history. But people had developed an attitude in the late 20th century that there are no bubbles, that markets are perfect. Free markets have important benefits. But we have learned that markets are not perfect. The word ‘bubble’, which was rarely used by financial professionals before, is now used all the time. People ask why that happened. You can’t point to any single person who is responsible. It’s a mass phenomenon that involves a change in all of our psychologies.

What lessons have been learned and what has been neglected?

One lesson that has been overlooked is that one has to be aware of one’s own psychological impulses. At a time when it looks like I should pile into some market which is going up, I have to understand that that is an incorrect impulse. For governments, the lesson has been about regulation and about standing up for the public in regulation. In terms of financial innovation, the lesson to be learned is that the problems revealed by the crisis can be eliminated by new financial mechanisms. Some people have drawn the conclusion that finance is evil. I think that’s the wrong conclusion. Finance is a technology, it’s about making things happen. It’s about sharing risks. And that technology has to be expanded and to be made operative.

Which events had the greatest influence on your dealing with risks over the past ten years?

The financial crisis itself did not in fact challenge my view about the way the world works. The wrong turn in policy, which took place in 2010/2011 – the shift to austerity policies, the abandonment of concerns about unemployment, the hysteria over inflation – was what really shook me. Until that point I had believed that the work I do, what I think of as rational argument in economics, had more influence than it turned out to have. That wrong turn was not driven by anything in particular. It wasn’t that there was a serious discussion, that there was new evidence brought to bear; it was simply political prejudice totally overriding what we thought we knew about economics.

What lessons will we learn from this?

There has been a definite change in views about the financial sector. A substantial part of the political spectrum now understands that there is a reason to regulate banks fairly tightly. We’ve actually been having this discussion in the US among economists. There has been a convergence among centre and centre-left economists who used to disagree a lot, but have converged quite dramatically in the wake of the crisis. They have discovered that actually we have a lot of common ground on issues from financial regulations to taxation to minimum wages. There is actually a surprising new consensus among a good part of people. People who would have been arguing fiercely with each other 15 years ago are now very much in agreement on a whole range of issues.

What lessons have been learned and what has been neglected?

The political process still deals badly with economic crisis. If I were trying to create an architecture of policy, many more things would need to be automatic. In the US system, the existing programmes actually worked very well. We had a terrible recession, poverty went up, but extreme poverty did not because the existing programmes protected people from the worst effects quite well. However, discretionary programmes that would have helped were pulled away almost immediately because the politicians found reasons to not want to do the right thing. So I think we need a system that does many more things on autopilot if we’re going to get through the next one.

Which events had the greatest influence on your dealing with risks over the past ten years?

I think for me it was not 2008 and 2009 but actually the 1970s, when we had an enormous array of shocks that hit our systems all at once, particularly in the United States: the Bretton Woods system was terminated, we had stagflation, we had high unemployment and we had a 10 per cent inflation rate. The US stock market lost about 50 per cent of its value in real terms over an 18-month period from 1973 to 1974. Another ‘minor’ event was the oil crisis, so all of this hit in one period.

What lessons will we learn from this?

We’re facing another set of big risks today, and we always will. But we came out of that very bad crisis of the 1970s by using an enormous amount of innovation. I hope that today we will take advantage of all the technology and knowledge that we have to improve our systems, address these challenges and again come out better.

What lessons have been learned and what has been neglected?

If I only had one thing that I could teach children everywhere in kindergarten through twelfth grade every year – just like repeating the national anthem or something you would teach them every year – it would be that there is one lesson in finance: there is no such thing as a free lunch. If it’s too good to be true, it’s probably not true. If they learned that and if we practised that, we would occasionally miss out on a few opportunities, but we’d stay out of an awful lot of trouble. If you analyse many of the behavioural elements of 2008/2009, there was a lot of believing – or wanting to believe – that too good to be true was indeed true.

Which events had the greatest influence on your dealing with risks over the past ten years?

I think the financial crisis has been quite influential on all of us. It was largely an unexpected event, though in hindsight its telltale signs were there. But once the scale of this financial shock became clear I think this had a major impact on many economists and on me. It has pushed me towards working more on issues of systemic risk – how small shocks can magnify because of the interaction between financial institutions or because one is a counterparty to another or because many financial institutions are at the same time investing in similar assets and therefore exposing themselves to similar risks.

What lessons will we learn from this?

The academic world has partly learned the lesson that some of these plumbing type issues relate to how different financial institutions connect to each other. What are the fine prints of the financial instruments that they are using? Those have to be taken seriously in a much more holistic approach. Financial risk is necessary, even if you are not a financial economist. For example, macroeconomics dealing with things like GDP and unemployment had largely ignored financial factors and now these have to be taken seriously. On the policy and bureaucratic side the lesson was that deregulation perhaps went too far and financial risks need to be regulated.

What lessons have been learned and what has been neglected?

I think the lessons were not fully understood or digested. Even though the diagnosis that financial deregulation had a lot to do with the financial crisis is partly correct, the solution is not to have detailed step-by-step regulations as for example in the Dodd Frank Act in the United States, which is far too detailed, but to try to deal with the holistic nature of these systemic risks. So in that sense the lessons may have been somewhat incorrectly learned or at least more time needs to pass for the lessons to be fully digested and turned into positive regulatory steps.

Which events had the greatest influence on your dealing with risks over the past ten years?

That was definitely the US banking crisis and then, following on its heels, the euro crisis. The rescue packages launched in response to these crises have not been very effective. The countries on the eurozone periphery are now desperately trying to regain their competitiveness gradually by imposing reforms and price restraint. But these efforts are being accompanied by mass unemployment that is virtually impossible to keep in check, and this is making people very disaffected. The Greeks have elected Syriza under Alexis Tsipras, who now wants to implement all sorts of radical measures. It is therefore essential for the European Union not to accede to all his demands because that could set a precedent for other governments.

What lessons have been learned from the financial crisis and the euro crisis?

Well, firstly, there are lessons for the banking system. The banks are undercapitalised and are engaged in highly risky business. They should therefore be compelled to hold much more capital on their balance sheets. They would then act prudently from the outset and reject excessively risky business models. However, we also need to stabilise Europe itself. I think we need to impose much tougher budget restrictions in the eurosystem. It should not be admissible for countries to print themselves out of their difficulties. Countries that have easy access to the printing press lack the incentive to implement painful reforms.

What lessons have not been learned and what has been neglected?

The banks’ minimum capital ratios should have been raised substantially as a consequence of the financial crisis. This has not happened. The Maastricht Treaty – especially its no-bailout clause – should have been taken seriously during the euro crisis. This would have required a bankruptcy law for countries. It is not enough to incorporate the no-bailout principle into the treaty simply as a rhetorical device. We need detailed guidelines that stipulate bankruptcy procedures. Although it may sound paradoxical, the possibility of bankruptcy is absolutely crucial to the stability of the system – not the actual existence of bankruptcy but its possibility. Only if bankruptcy is possible will it not happen in the first place.

Which events had the greatest influence on your dealing with risks over the past ten years?

Three events have changed the way we view risk: 9/11, the 2008 crisis and Russian intervention in Ukraine. Out of these, our own economic crisis was structurally the most devastating, we did this to ourselves. There is not only a probability but also the probability of a probability – that our probabilities are based on incorrect models. The future is fundamentally unpredictable. It doesn’t help to pretend otherwise. Our biggest threat is within our civilisation, not outside. We are perhaps the strongest civilisation, yet we may be brought to our knees by our own self-inflicted issues, such as debt.

What lessons will we learn from this?

We are still back to “Father, please forgive us, for we do not know what we are doing” to paraphrase the famous prayer of Jesus. Only in our case we need to ask society for forgiveness. But even though we do not know, and we are ready to admit it, we want to speed up and don’t want to create reserves. We are not sure of the direction, but we compensate for this fundamental uncertainty by speeding up. We still think it was the lack of confidence and trust that brought about the crisis, but it was exactly the opposite, it was the overconfidence and lack of carefulness that brought the near collapse of our civilisation. We have not learned much and are still ready to sell stability in order to buy growth. It’s a dangerous and costly growth that we seek.

What lessons have been learned and what has been neglected?

We still don’t know what to do if a big economy goes bankrupt. We have been lucky that the bankruptcies in Europe have always affected small economies, so we were able to solve them in a non-standard way. We still don’t know how to trim our manias. We don’t know how to apply our fiscal and monetary policy properly. Today economists claim that the world works according to economic rules, just like the Pharisees once claimed that the world works according to certain ethical rules. But the bone that Jesus had to pick with the Pharisees, his message, was that there is a deeper underlying meta-structure of which reality is forged. That’s why Jesus talked so much about love, mercy, forgiveness. These are things that fundamentally cannot be put into rules.

Which events had the greatest influence on your dealing with risks over the past ten years?

Well, I am tempted to say the financial crises of 2007 and 2008. But in fact I think I started to feel very dubious about the increasing mathematical nature of risk management before that. I think the tendency of people to assume that there are natural science rules for financial markets is something I have become more and more sceptical about. And I think that came to a head with the financial crises.

What lessons will we learn from this?

Partially I think people learn that that doesn’t work very well but they never stop trying. I am not sure what the solution is. I think you have to try to use models but you have always to look over your shoulder and understand that in any case the world isn’t going to satisfy the formulae that you write down. People are looking for idols – idols in the sense of things that are man-made but nevertheless behave like human beings. That doesn’t happen. You can write down models but you have to understand that at some point they are not going to work at all. Maybe you will be lucky and do better than the models; maybe you will be unlucky and do much worse.

What lessons have been learned and what has been neglected?

People use very complicated mathematics to describe financial markets. I am not saying it’s not a worthwhile thing to do. The syntax they use looks like financial science but the semantics is very different. It just doesn’t work well. People tend to forget that by using a very accurate language, they somehow start to imagine that what they are doing is accurate.

Which events had the greatest influence on your dealing with risks over the past ten years?

I think the financial crisis hit not just me but virtually the entire profession really hard. When the British Queen visited the London School of Economics to mark the institution’s centenary, she asked in her wonderfully refined English way why, given that there were so many eminent economists working there, nobody had seen the crisis coming. In other words, it came as a shock to the entire profession and triggered new initiatives in the field of risk research. A large number of studies analysed financial market risk much more rigorously than had previously been the case.

What lessons have been learned from the financial crisis and the euro crisis?

I think it is incumbent on us all to do everything we possibly can to ensure that this kind of thing never happens again. However, we should disabuse ourselves of the notions that economic trends always proceed without creating any tensions, that there will be no more crises in financial markets and that we will see no more fluctuations in the business cycle. We really need to rid ourselves of this illusion. The economy moves in fits and starts that have both positive and negative impacts, and this will always be the case. What we must prevent at all costs, however, is the possibility of such extreme boom and bust occurring again that it could push the world to the brink of disaster.

What lessons have not been learned and what has been neglected?

Although many of the proposals made on financial market regulation have been implemented, we certainly have no reason to rest on our laurels yet. The current regulatory system is still far from perfect, and we can once again see signs of certain kinds of speculation being repeated in financial and real-estate markets. We need to nip this trend in the bud, and this requires us to monitor events very closely.