crisis, they did not know what they did not know. or, as donald rumsfeld might have put it, there were too many “ unknown unknowns. ” the profound uncertainty associated with the “ unknown unknowns ” during the crisis resulted in panicky selling by investors, sharp cuts in payrolls by employers, and significant increases in households ’ precautionary saving. the idea that, at certain times, decisionmakers simply cannot assign meaningful probabilities to alternative outcomes – indeed, cannot even think of all the possible outcomes – is known as knightian uncertainty, after the economist frank knight who discussed the idea in the 1920s. although economists and psychologists have long recognized the challenges such ambiguity presents and have analyzed the distinction between risk aversion and ambiguity aversion, much of this work has been abstract and relatively little progress has been made in describing and predicting the behavior of human beings under circumstances in which their knowledge and experience provide little useful information. 10 research in this area could aid our understanding of crises and other extreme situations. i suspect that progress will require careful empirical research with attention to psychological as well as economic factors. another issue that clearly needs more attention is the formation and propagation of asset price bubbles. scholars did a great deal of work on bubbles after the collapse of the dot - com bubble a decade ago, much of it quite interesting, but the profession seems still quite far from consensus and from being able to provide useful advice to policymakers. much of the literature at this point addresses how bubbles persist and expand in circumstances where we would generally think they should not, such as when all agents know of the existence of a bubble or when sophisticated arbitrageurs operate in a market. as it was put by my former colleague, markus brunnermeier, a scholar affiliated with the bendheim center who has done herein i use the extension of von neumann - morgenstern expected utility, which focused on objective probabilities over risks, to situations in which individuals assign subjective probabilities over risks. for a review of some classic contributions in this area, see jacques h. dreze ( 1974 ), “ axiomatic theories of choice, cardinal utility and subjective probability : a review, ” in jacques h. dreze, ed., allocation under uncertainty : equilibrium and optimality ( london : macmillan ), pp. 3 – 23. some authors have used risk to refer to a situation of objective probabilities and uncertainty to refer to a situation

the recent legislation creates a financial stability oversight council, made up of the heads of the financial regulatory agencies, which will assess potential risks to the financial system, identify regulatory gaps, and coordinate the efforts of the various agencies. enhanced market see, for example, marvin goodfriend and bennett t. mccallum ( 2007 ), “ banking and interest rates in monetary policy analysis : a quantitative exploration, ” journal of monetary economics, vol. 54 ( 5 ), pp. 1480 – 1507 ; and lawrence j. christiano, roberto motto, and massimo rostagno ( 2009 ), “ financial factors in economic fluctuations, ” paper presented at “ financial markets and monetary policy, ” a conference sponsored by the federal reserve board and the journal of money, credit and banking, held in washington, june 4 – 5. for examples of studies that emphasize bank capital as a constraint on financial intermediation, see skander j. van den heuvel ( 2008 ), “ the welfare cost of bank capital requirements, ” journal of monetary economics, vol. 55 ( march ), pp. 298 – 320 ; cesaire a. meh and kevin moran ( 2008 ), “ the role of bank capital in the propagation of shocks, ” bank of canada working paper 2008 – 36 ( ottawa, ontario, canada : bank of canada, october ) ; and mark gertler and peter karadi ( 2009 ), “ a model of unconventional monetary policy, ” manuscript, new york university, june. an example of recent research on this subject is : joseph gagnon, matthew raskin, julie remache, and brian sack ( 2010 ), “ large - scale asset purchases by the federal reserve : did they work? ” staff report no. 441 ( new york : federal reserve bank of new york, march ). see also gertler and karadi ( 2009 ), footnote 14. discipline, the result of a new resolution regime for systemically critical firms and a number of measures to increase transparency, will complement regulatory oversight. finally, numerous steps, both prescribed in the legislation and taken independently by regulators, will work to make our financial system more resilient to shocks. examples include rules that will strengthen key financial utilities, toughen bank capital and liquidity standards, and require that more derivatives instruments be standardized and traded on exchanges rather than over the counter. economic engineering is effective only in combination with good economic management. for its part, the federal reserve has