Foreword: Interpreting - And Learning From? - Yet Another 'Meltdown'
17 Pages Posted: 16 Oct 2013
Date Written: October 15, 2013
Abstract
This foreword to a symposium volume dedicated to lessons learned from the financial dramas of 2008-09, in addition to contextualizing the other published contributions, suggests that even quite clever people in recent decades have failed to look out for and preempt asset price bubbles and busts thanks to two misconceptions. The first misconception is that bubbles and busts would be incompatible with rationality on the part of financial market participants, hence cannot occur. This is a mistake because asset price bubbles and busts constitute what this author elsewhere calls 'recursive collective action problems,' a hallmark of which is precisely that they aggregate multiple individually rational actions into collectively calamitous outcomes. (Arms races, consumer price hyperinflations, liquidity traps and 'paradoxes of thrift' are other well known examples.) The second misconception is that bubbles and busts would be incompatible with informational efficiency on the part of financial markets, hence either cannot occur or at any rate cannot be known to be developing ahead of their occurring. This is a mistake for two reasons. First, because markets' informational efficiency is an attribute of their impoundment of available information, not all conceivable information; and information concerning precisely when indefinitely extensible credit will cease to be extended is just not available to private market actors. And second, because regulators with authority to collect or force disclosure of information concerning leverage accumulation economy-wide, growing spreads between finished goods prices and materials prices, or both can effectively fill the consequent gap. The piece concludes with a call for a forthrightly macroprudential, bubble-preemptive approach to financial regulation.
Keywords: Asset Price Bubbles, Busts, Credit Bubbles, Efficient Markets, Efficiency, Finance, Financial Crisis, Financial Regulation, Informational Efficiency, Macroprudential Regulation, Market Rationality, Microprudential Regulation, Rationality
Suggested Citation: Suggested Citation