The insidiousness of the formal risk mindset

19/10/2022 ☼ risknot-knowingmindset

tl;dr: We need to be vigilant about mindset mismatch because serious mindset mismatch causes bad decisionmaking which often leads to terrible outcomes. This article argues that formal risk mindset is insidious and seductive, which is why even experienced decisionmakers instinctively adopt the formal risk mindset without being aware of it. But formal risk mindset is often seriously mismatched to the situations of not-knowing to which it is applied, making bad outcomes much more likely. This is the second of two articles about the consequences of mindset mismatch (here’s the first).

🙏 to David Bray, James Cham, and Ian O’Donnell, and Giulio Quaggiotto for their comments. I am responsible for any remaining poor thinking.

A mindset is a set of beliefs which determine what you perceive of the world, how you interpret what you perceive, and how you choose to act on that interpretation. This is why mindset mismatch leads you to choose the wrong actions to deal with the situation. Wrong” here means 1) your actions did not produce your desired results or 2) your actions produced unexpected other results which you don’t want or 3) both (this happens all the time). When the mindset mismatch is serious, this results in bad decisionmaking and terrible outcomes. 

This is especially problematic because formal risk mindset is so insidious and seductive that it is habitually (even unconsciously) adopted by decisionmakers even in situations of not-knowing for which it is highly inappropriate. We have to remain extremely vigilant against this kind of serious mindset mismatch.

An example illustrates:

The Bank of England’s mindset

Like many other national central banks, the UKs central bank, the Bank of England (BoE), tries to manage the UKs national economy. The BoE’s desired management outcomes are, broadly, some target ranges for annual GDP growth, inflation, and unemployment because academic economists believe these numbers reflect a healthy economy. It’s fair to say that central bank decisionmakers are driven by macroeconomic theory, which is a mindset which comes with many fundamental beliefs about how the world works, and what kinds of actions have what kinds of results. The relevant parts of this mindset are a belief that 1) you have a healthy economy if you can reach target numbers for GDP growth/inflation/unemployment, and 2) you can control the level of those target numbers by adjusting the size of the money supply (i.e., how much money is sloshing around in the system). 

Central banks like the BoE can take several types of actions to adjust money supply. 

The actions with the most diffuse effects are the ones which are designed to change how expensive and difficult it is for commercial banks to make loans to companies and regular people. The easier and less expensive this is, the more loans get made, and the more money gets injected into the economy. The BoE’s main action for achieving this is lowering the interest rate on loans the government makes to banks. The lower this interest rate, the cheaper it is to borrow money from the government. Commercial banks can make loans at lower interest rates, and this makes businesses and consumers take more loans and spend the money they borrow on stuff like houses, cars, washing machines, or new factories. 

Central banks must sometimes take actions that are designed to quickly produce much less diffuse effects when there’s a sudden economic shock — such as if there is a massive currency devaluation and imminent pension fund collapse in the wake of an imprudent economic policy announcement. The most common of these specific actions is choosing to either buy or sell government debt in the form of bonds. When a central bank pays cash to buy back government bonds, it puts cash into the economy and increases the money supply. such as emergency buying of government bonds . 

The BoE has taken both these diffuse and specific actions recently, and  encountered all three of the problems associated with mindset mismatch — some quite recently. Not only have their actions not had the desired and expected effects, they have almost always had other effects which were undesirable.

Bad outcomes from serious mindset mismatch at the BoE

Very low BoE interest rates from January 2009 until May 2022 (at or under 1% that whole time, and as low as 0.1% for more than 18 months in 2020 and 2021) were designed to stimulate the UK economy and increase GDP growth and reduce unemployment. This did not work as well as expected for many reasons, including Covid-19 and Brexit. However, over a decade of very low interest rates nonetheless seems to have caused house prices to balloon in the UK because low-interest home loans allow more people to pay more for houses. This resulted in a cost-of-housing crisis

Very recently, the BoE was forced to announce that it would buy unlimited quantities of long-maturity gilts to stabilize the market and save UK pension funds. The objective of this announcement and commitment was to reverse the suddenly devaluation of the pound and UK government bond (gilt) prices that happened after various economic policy changes were announced by the UK government in its September 2022 mini-budget. The operation was not especially successful in returning the pound to its value before the policy announcement. This action caused two other results which were undesirable. Some market observers read the BoE announcement as a sign that the UKs economic situation was more dire than expected, which in fact added to downward pressure on the pound. Other market observers read the BoE announcement as a sign of growing moral hazard, giving politicians dangerous confidence that even silly policy decisions (like unfunded tax cuts) can be made with impunity because the BoE will always step in if those policy decisions mess up the economy.

The macroeconomic theory mindset believes the economy is a system that’s very complex but can be reduced to an functional and quantifiable abstraction that’s much simpler yet still essentially correct — numbers for GDP growth, inflation, and unemployment. This mindset also believes that specific actions (controlling the money supply in various ways) have specific causal effects on those critical numbers. 

The BoE too has a serious mindset mismatch. Its actions in this situation (both multi-year management of the economy and specific management of the fallout from the mini-budget in September) did not result in expected outcomes and also produced undesirable outcomes. The UK economy cannot be abstracted the way the macroeconomic theory mindset believes it can — it is both more complex and more unpredictable. If you have a macro theory mindset,  it makes you interpret the economy as being less complex and unpredictable and more simple and controllable than it actually is. Your view of the situation is inaccurate. When you misinterpret what the economy in this way, you take actions which don’t work the way you expect and often have results which you don’t expect. which is why there have been bad outcomes from using it to make decisions.

Bad outcomes result from serious mindset mismatch because you profoundly misinterpret the nature of the reality you have to deal with and choose the wrong actions to achieve your desired outcomes.

Formal risk mindset is dangerously insidious

I used the BoE as a whipping boy here because the mini-budget kerfuffle is so recent and top of mind. But there’s another reason this example is useful. It also (surprise!) illustrates the deeply buried issues with the formal risk mindset when confronted with a situation of not-knowing that isn’t formally risky. 

The reason for this is: The macroeconomic theory mindset is intimately connected to the formal risk mindset. In fact, it is nested inside it. 

You can’t really believe in macroeconomic theory (or that it works in the sense that you can use it to manage the economy of an actual country) without first believing that complicated situations are ultimately abstractable to a knowably complete set of outcomes whose probabilities can be known as well. This is a fundamental belief of the formal risk mindset. This fundamental belief is the foundation for other beliefs, such as the ancillary belief that actions to change outcomes can be quantitatively decided based on the probabilities of the respective outcomes. This is the justification for making decisions that are viewed as unambiguous based on expected outcomes. 

This is another way to say that the macroeconomic theory mindset and the formal risk mindset inside which it nests are both ways to see the world which justify an operation for taking any situation of not-knowing and viewing it and acting on it through a comforting lens that the situation is knowable and actionable — even when it’s not.

Formal risk mindset instinctively seeks clarity … even when it’s inappropriate  

When the situation of not-knowing is not formally risky, the comfort of unambiguous numbers is false comfort. In these kinds of situations (see the previous article about how to think clearly about risk), we simply lack enough information to use quantitative methods to make unambiguous decisions based on expected outcomes. 

Let me be clear: I’m not saying that quantitative reasoning is always bad. What I’m saying is that we should think about the foundations and implications of quantitative reasoning especially when we use it to make decisions in situations of not-knowing. Quantitative decisionmaking — especially when it is highly technical — takes numbers (which appear clear and unambiguous whether or not they map onto a clear and unambiguous reality) and produces results that are very easily, even instinctively, interpreted as being clear and unambiguous.1 

The formal risk mindset is founded on the belief that it’s possible to know outcomes, their probabilities, and the actions that produce them. It’s a mindset that, deep down, believes that the world is clear and unambiguous. This is why the formal risk mindset is so intimately connected to decisionmaking approaches that rely on clear and unambiguous quantification of actions and their relationships to outcomes. 

It’s deeply problematic that the formal risk mindset is so insidiously ubiquitous. When the situation doesn’t warrant clear and unambiguous decisions, we should be extremely wary of instinctively choosing a decisionmaking mindset that is so easily viewed as producing clarity and unambiguity.

This is the case for most situations in which the formal risk mindset is in play. As I’ve argued before, risk” is now used to describe many situations of not-knowing that aren’t formally risky. This means that we instinctively interpret almost every situation of not-knowing through a formal risk mindset. 

Unfortunately, most of the time, the situation isn’t actually formally risky. This means formal risk mindset is inappropriate — it’s mismatched to the situation. In the BoE’s case, the mismatch was serious and the outcomes were terrible and will probably continue to be terrible for a while.2  

Vigilance is vital

To summarise: A mindset is a set of beliefs about the world. This set of beliefs tells me what the world’s mechanisms are, how I can operate them, and what happens when I operate them in particular ways. If the beliefs map onto the mechanisms correctly, I will be able to operate the mechanisms safely and get the results I expect. Mindsets allow me to take action because they function both as ways of seeing the world and of understanding how I can act in it — models of causation.

A mindset can only be appropriate and match the situation when it fulfils two conditions at the same time:

  1. It lets me see the world clearly: It does not make me mistake the world for something that it isn’t, and
  2. It gives me a correct causal model for that worldview: It tells me what actions I can take in that world, and correctly tells me what will happen when I take those actions.

When 1 and 2 are both true at the same time, I have a mindset that matches the world. I correctly interpret the world for what it is, and I have an accurate causal model that tells me what to do to get the outcomes I want.

If only 1 is true, I see the world correctly but act incorrectly in it. If only 2 is true, I see the world incorrectly and therefore I act incorrectly in it. In both cases, there is mindset mismatch and mistaken models of causation. 

When mindset mismatch is serious, it causes really bad decisionmaking because it inevitably results in seriously mistaken ideas about how the world works. Formal risk mindset is so insidious that it is often adopted by instinct, even when it isn’t well-matched to the situation.

Vigilance is vital. If we don’t actively interrogate our mindsets, they’re more likely to be seriously mismatched to the situations we face — and terrible outcomes are more likely too.

This article is part of a project on not-knowing.

  1. The formal risk mindset and the quantitative decisionmaking approaches that come with it are artefacts of certainty.↩︎

  2. To be fair to the BoE, the terrible outcomes were made much worse by highly questionable policy decisions made by the government in the September mini-budget and its aftermath.↩︎