The uselessness of “bubble” talk

By Lorenzo

This is based on a comment I made here.

If turning points in asset prices could be reliably predicted, they wouldn’t happen (since no none would buy at the “about to be seriously undercut” price).

The “bubble” folk don’t seem to understand that calling it a “bubble”:

(1) entails not knowing when the turning point will happen;

(2) means prices are reflecting current information, not information that hasn’t become available yet.

Given that it is a principle of modern physics that there is no information from the future, it hardly seems likely that economics can squeeze out such information.

The most one can squeeze out is that there may be herd effects in asset prices (i.e. people think prices will rise, act on that shared belief, so prices rise). But as we have no idea when the herd effect will stop happening (see [1]), that doesn’t get us very far. After all, herd effects (possibly “flock effects”, as the mechanisms seem similar to bird flock movements: a manifestation of the perennial human habit of adopting social heuristics that economise on information) can operate in either direction.

Identifying what is driving current asset prices movements, and how robust those factors are, is useful, but that is useful without adding in the “bubble” usage.

So, all a “bubble” claim ends up doing is something saying something like “I believe current asset prices are based on thinly grounded expectations which will collapse at some unspecified (indeed, unknown) point in the future”. Doesn’t seem to get us very far–apart from being an awful basis for monetary policy, especially given the (fairly disastrous) track record for such actions: which is hardly surprising as deliberately creating asset price instability is hardly a good basis for a stable growth path for an economy.

 

[Cross-posted from Thinking Out Aloud.]

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