Academic journal article Federal Reserve Bank of New York Economic Policy Review

Part 3: Systemic Risk in Ecology and Engineering

Academic journal article Federal Reserve Bank of New York Economic Policy Review

Part 3: Systemic Risk in Ecology and Engineering

Article excerpt

Several fields of engineering and science share with economics a keen concern with systemic risk. Systemic risk is manifested in space shuttle accidents, airplane crashes, the collapse of the New Orleans levees, electrical power blackouts, and the failures of buildings, bridges, and many other engineered systems. Because of these occasional system failures, engineers have more relevant data for the study of systemic risk than do economists. Using these data to conduct retrospective analyses of system problems, engineers have been able to identify and remove some sources of failure (for example, in aircraft). Similarly, epidemiologists and public health experts worry about disease outbreaks and spread, which occasionally reach systemic levels, and they have learned lessons in risk management by studying past epidemics. And ecologists study changes in the state of ecosystems, which may receive less press attention but clearly qualify as systemic developments because they can result in a true regime shift from one equilibrium to another.

There are two ways that one discipline can leverage the experience of another. The first way is by adapting methodologies developed in one field to analyze structures and phenomena in the other field. The examination of the Federal Reserve's Fedwire system in part 4 of this volume exemplifies this mode of intellectual sharing: researchers adapt tools from outside of economics--namely, network theory and graph theory--to learn what insights can be gained by applying them to a problem of systemic behavior in the area of payments. The second way is by sharing insights that are particular to a given field and that, by analogy, might apply to other fields. This is the approach taken in this part of the volume.

Useful Concepts from Ecology and Engineering

At the conference, ecologist Simon Levin of Princeton University identified a range of concepts that have proved helpful in understanding complex systems in ecology and that might also apply to financial systems. One useful conceptual model of an ecosystem is a "trophic web," which represents how species are interconnected. At a coarse level, a trophic web in an ecosystem might be thought of as a set of predator-prey relationships. In this case, sets of differential equations can be successful in modeling the rise and fall of populations as the ecosystem fluctuates around an equilibrium or becomes unstable. More generally, however, "trophic" refers to the flow of energy, so the trophic web for an ecosystem is a framework for representing how the primary source of nutrition (say, sunlight or geothermal vents) is transmitted between levels in the food chain. This interpretation of the trophic web is more applicable to financial systems, in which the interactions are usually less extreme than those in predator-prey relationships; we simply have to interpret "energy" as anything of value that is transmitted through the system. Because of this analogy, it is not surprising that we would find similar, if not identical, phenomena in these two systems, and therefore similar insights might be brought to bear in analyzing them. Complex systems of any sort are characterized by nonlinearities, multiple stable states, hysteresis, contagion, and synchrony, all of which have relevance to the problem of systemic risk.

Nonlinear relationships are a key characteristic of virtually any complex system. They can lead to multiple stable states, The views expressed in this summary do not necessarily reflect the position of the Federal Reserve Bank of New York or the Federal Reserve System. such that the system can exist in one configuration (basin of attraction) for a period of time but then be knocked into a different configuration by a perturbation or shock. This transition can be accompanied by hysteresis, meaning that if the system is to return to its original configuration, it must take a different path. Often, pain and other costs are associated with that recovery pathway. …

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