Virginia Postrel a href="http://www.theatlantic.com/doc/print/200812/financial-bubbles"thinks/a they are, because bubbles occur even in controlled experiments. This, Postrel argues, casts doubt on the idea that regulations can curb asset bubbles:blockquoteThese lab results should give pause not only to people who believe in efficient markets, but also to those who think we can banish bubbles simply by curbing corruption and imposing more regulation./blockquoteEven if we grant the premise that the experimental results Postrel cites in her article say much of anything about real-world asset bubbles, it's still wrong to conclude that the results weaken the argument for regulations aimed at preemptively curbing asset bubbles. All the experiments show is that under a certain set of highly-simplified conditions, asset bubbles appear to be inevitable. They say nothing at all about the occurrence of asset bubbles span style="font-style: italic;"under conditions which include regulations aimed at preemptively curbing asset bubbles/span. If anything, the experimental results Postrel cites span style="font-style: italic;"strengthen/span the case for preemptive regulations.br /br /To that end, may I somewhat selfishly recommend a href="http://www.ft.com/cms/s/0/c9738158-b24d-11dd-bbc9-0000779fd18c.html"this considered proposal/a from Roman Frydman and Michael Goldberg (I had Professor Frydman for Applied Economics, and his wife for a brutal Stochastic Modeling class at Stern):blockquoteTo institutionalise the importance of acknowledging imperfect knowledge, new regulations should be adopted that require every rating agency to issue multiple ratings for each security, which would make explicit the fact that the risk of default depends crucially on the magnitude and duration of departures from historical benchmarks.br /br /Beyond rating reforms, central banks should announce on a regular basis ? as some now do with regard to inflation ? a range of benchmark values for key asset markets. The idea behind these announcements is to make it more risky for market participants to continue to place too little weight on departures from the benchmark in their trading. This would moderate their willingness to bet on greater departures, thereby limiting the magnitude of price swings.br /br /But governments can do even more. As an asset price moves beyond the non-excessive range, margin and other capital requirements should increase for those who want to take positions that push the price farther away from the benchmark.br /br /Since every long swing is different ? the benchmark itself can change over time due to changes in technology and the social context ? the central bank should be given discretion to widen or narrow the range as our imperfect knowledge unfolds. Such decisions should be accompanied by detailed explanations of the central bank?s assessment, which would enable quality control by the public.br /br /Limiting excessive swings does not call for central banks to confine asset prices to a pre-specified target zone. ... Instead, the limit-the-swings changes in capital requirements and central banks? regular announcements of a range of benchmark values aim to increase the risk of capital losses from betting on greater departures.br //blockquoteFrydman and Goldberg's proposal is an extension of their a href="http://press.princeton.edu/titles/8537.html"groundbreaking work/a on imperfect information and exchange rates.img src="http://feeds.feedburner.com/~r/economicsofcontempt/~4/490357214" height="1" width="1"/
