Asset price bubbles

As the various asset price bubbles of the past decades or so inflated, and in some cases burst, there was vigorous debate about what, if anything should be done about them. The two main camps were those who advocated doing nothing, on the grounds that monetary policy should be focused solely on inflation, and those who thought that the settings of monetary policy should take asset prices into account. The first group won the debate at the time, at least as far as actual policy was concerned, with consequences we can all see. Most proponents of the do-nothing viewpoint have conceded defeat

In a paper in the (institutionalist) Journal of Economic Issues, which came out in 2006, Stephen Bell and I took a different view of the debate. We argued that there was little scope to respond to asset bubbles by changing the settings of existing monetary policy instruments, and that “any serious attempt to stabilize financial market outcomes must involve at least a partial reversal of deregulation.” Among other things, we pointed out the fact that given a presumption in favour of financial innovation, asset prices bubbles were inevitable, and that ‘In the absence of a severe failure in the financial system of the United States, it seems unlikely that ideas of a ‘new global financial architecture’ will ever be much more than ideas.’

You can read the full paper
Bell, S. and Quiggin, J. (2006), ‘Asset price instability and policy responses: The legacy of liberalization’, Journal of Economic Issues, XL(3), 629-49.

here

30 thoughts on “Asset price bubbles

  1. Katz,
    That’s a very good point. I’d also add that everybody who didn’t sell credit (almost all of us) was just as irrational as the risk-takers who bought it.

  2. isn’t it possible that the management of the economy is actually much simpler than cosmology or high energy physics?

    can it it be that if commercial activity was reported quickly to a central computer, the nation could be run effectively?

    is the latest collapse of the figleaf of rational and responsible management enough to stimulate academia to design and promote an actual financial system that works?

    no. discussion remains centered around the aerodynamic qualities of politically correct angels in transition patterns over the (pin)heads of our current political masters.

    fortunately,don horne thought he was being satirical when he styled this wide brown land “lucky”. if he’d realized it was the truth, he would have had to find something punchier, “the kingdom of the blind to the threadbare evanescence of the emperor’s official deputy’s financial newish clothes” comes to mind.

  3. can it it be that if commercial activity was reported quickly to a central computer, the nation could be run effectively?

    That may work for as long as folks are prepared to stay within the algorithms encompassed by the computer. This would be a strictly closed system with a finite set of rules and a finite number of allowed outcomes, like draughts. In fact, an economy is more like poker, which isn’t a closed system and which allows potentially an infinite number of winning (and losing) outcomes.

    So long as there is incentive to do so, any system, no matter how tightly structured it is, can in the real world be gamed.

    Paradoxically, it might be argued, the tighter the system, the bigger the bubble and the worse the crash, when it finally arrives, as it will.

  4. John, if I may reply to Andrew Reynolds by saying if consumers had perfect knowledge of markets then they would not have been unwittingly fleeced by predatory mortgage lenders as was the case in the USA before the real estate bubble burst.

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