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Lars Peter Hansen

Lars Peter Hansen

An Uncalculated Path

The sun hasn’t made its way over Logan Peak as Lars Peter Hansen, ’74, sits down for breakfast. The day before he shook hands with the governor of Utah. In a few hours he will visit a fifth-grade class at Adams Elementary School, and later, discuss uncertainty in financial markets before a packed performance hall at Utah State. Since winning the Nobel Memorial Prize in Economics, people are paying more attention to what Hansen has to say—and that takes some getting used to.

Do fifth graders know what a Nobel Prize is?” Hansen asks between bites of English muffin. Moreover, how does one explain complex economic theory to an auditorium of people who don’t study economics? He will leave out the math. That seems like a good plan, he says. Hansen, the David Rockefeller Distinguished Service Professor in Economics and Statistics at the University of Chicago, explores the linkages between the macroeconomy and financial markets. In October, he and Eugene F. Fama and Robert J. Schiller were awarded the Nobel Prize for their empirical work on asset pricing. To do this involves building statistical models wherein various components of uncertainty exist. Uncertainty—the word has a different meaning in economics than in everyday use. It implies doubt. In economics, it is akin to that which is unmeasurable. It is the difference between being wrong and being closer to right.

“Anyone who builds models, at the end of the day, they’re wrong,” Hansen said.

But, he argues, that doesn’t mean models should be dismissed. They can provide accurate forecasts over time. What’s important is to acknowledge the imperfection of models and learn whether the errors are consequential.

“For an economist modeling things like investment decisions for policy analysis, and thinking about how people and markets respond to uncertainty, it ends up being a very important question,” Hansen said. “The challenging part of this is, at the end of the day, I am a person who wants to build models and do stuff with them.”

This desire to do something with data is something that he has felt since his freshman year at Utah State. He enrolled during the Vietnam War Era and felt compelled for his work to be “socially relevant.” However, the type of calculated thinking required of Hansen’s day job as an econometrician is not something he has always applied to his personal life. He doesn’t view it as a series of planned steps taking him from point A to point B to Nobel Laureate.

“This wasn’t some calculated strategy,” Hansen said. “It just kind of happened. I stumbled into good luck and maybe I was smart enough to use it.”

Hansen moved to Logan at age 16 when his father accepted a position as the provost of Utah State. For his parents, both Smithfield natives, it was a homecoming. For Hansen, it was a rough transition.

“I was a very, very shy person. I probably still am,” he said. “Growing up, I actually had stuttering issues and so I really avoided anything related to public speaking.”

In high school, his grades were erratic and he was considered a troublemaker. When it came time to apply for college, Hansen’s options were limited—Utah State was the only place he could attend. He majored in political science and mathematics, and pursued a minor in economics, viewing it as a way to address important social problems, he said.

Afterward, Hansen attended the University of Minnesota because it allowed him to take math and economics classes simultaneously and he wound up studying with some leading scholars in the field. Before graduating, his advisor warned him that his foray onto the job market would be challenging because he “looked better on paper than in person,” Hansen said. And it was. After more than 20 interviews he received just one job offer at Carnegie Mellon University. While it turned out to be a great launch pad for his career, looking back, Hansen believes his success has been more about luck and taking advantage of it.

“It’s maybe looking at different environments and figuring out how to exploit them is the most I can say,” he said.

To study interconnections between the macroeconomy and financial markets requires writing a model that includes specifications for all conditions in both, a feat he argues is impossible to do with precision. So in 1982, Hansen devised a workaround that didn’t involve writing a full-blown model of everything. This process, the generalized method of moments, is what the Nobel committee cited him for, and is now used throughout social science research. Thirty years later, Hansen is thinking about uncertainty a little differently.

“My evolution kind of shifted from this notion of how does this outside person analyze a model to how people inside the model are coping with uncertainty,” he said. “Economists, when they build models, are different from people in physical sciences who make models because we’ve got people inside our models. And we have to be thinking about how people inside the models are behaving.”

The modeling Hansen was studying gained traction in the news after the financial crisis of 2007-08. It revealed gaps in the actual financial models being used, and political pressure mounted for regulatory agencies to act quickly—a move Hansen cautions against without understanding exactly what you’re regulating. Hansen and a group of senior economists formed the Macro Financial Model group to try to improve models down the line.

“I’m very worried about regulatory complexity,” he said. “I think there ought to be a big push towards keeping things simple and transparent. Because the more complications you add, the more uncertainties you have, and I’m not sure that’s quite so helpful [for policymaking] … A complicated problem doesn’t always require a complicated solution.”

Don’t be fooled. Prescribing policy recommendations at 7 a.m. over coffee is not the same as proffering ideas to the press. While Hansen has not sought the limelight in the past, he has started speaking out after he felt public sector research groups were pressed to offer solutions that just aren’t available under the guise of buzz words like “systemic risk,” he said.

“I worry sometimes the economists that have the most influence are the ones that project themselves most confidently to politicians,” he said. “And I often feel this confidence is somewhat false. It’s not always based on good solid empirical evidence. It’s basically a lot of their opinion and that’s never quite differentiated right. There’s lots of stuff in the economics profession that we don’t really know that well. [It] doesn’t mean that we shouldn’t be acting, but I think we would be better off acknowledging our knowledge limitations and designing the policies accordingly.”

Unfortunately, he admits, it’s that assertion that gets you on radar screens of reporters and politicians. Hansen warns that understating uncertainty in models may impede the ability to craft sensible policy and asserts that economists are closer in their views about handling fiscal challenges than is portrayed in the media. “Somehow [it] pitches us in these extremes where we seem to not be able to find middle ground that are productive,” he said. “I think it’s been kind of counterproductive for economic policy.”

Hansen understands the notoriety that comes with winning a Nobel Prize can be a useful way to shine a light on research he supports. For example, he recently joined a multidisciplinary center aimed at applying dynamic modeling to study uncertainty in climate science. However, six months later, he is still processing what winning a Nobel means for the future.

“I’m the same person I was, but lots of people treat me differently,” he said. “There’s this abrupt shift in how you’re perceived and that’s been interesting to adapt to. Lots of people are telling me I should be enjoying it more than I am. There’s [also] a little bit of an opportunity here to do something productive going forward with the extra attention. I think the real challenge for me is to figure out what that might be.”