On Bubbles, Markets, and Libertarians

Over at Econlog, Scott Sumner has an interesting post on bubbles and libertarians. In his post, he asks why libertarians, which generally accept markets as rational, tend to see bubbles everywhere.  It’s an interesting post and well worth a read, but I do not agree with him on several items.

But let’s start where I do agree: libertarians do tend to see bubbles everywhere.  It’s almost like the libertarian equivalent of the “market failure” argument interventionists use to justify government intervention.  Basically, whenever prices do not match what they think the price should be, it’s a bubble (or bubble popping).  There may be cases where there are bubbles, but not all swings in price constitute bubbles.

However, I think Scott too quickly dismisses the role of monetary policy in potential bubbles.  Interest rates are prices, and when prices are manipulated they send incorrect signals about relative scarcity of resources, which can lead to malinvestment and, in turn, bubbles.  To be accurate, the Federal Reserve does not set interest rates; it attempts to influence them through monetary policy but the Fed cannot directly control interest rates. To that end, the effect monetary policy has on bubbles is likely relatively moderate compared to the effect direct price controls (such as price ceilings or floors).  But it likely still has an effect.

I think his treatment of markets as always rational is incorrect.  Markets are generally rational, absolutely, but they are also just collections of men and men are flawed.  It certainly is possible that any given market at any given time could be irrationally priced.  Imperfect information, externalities, these things happen.  But does this weaken the case for markets and strengthen the case for government intervention, as Scott says?  I say no.  The same issues that infect markets infect government intervention, but in greater magnitude.  Markets needn’t be perfect to be the preferable option.  They need only to be better than the other options, and the record on that is crystal clear.  In short, I don’t see why recognizing markets as being imperfect necessarily weakens the case for libertarianism (especially as long as markets are allowed to adapt to irrational behavior).

Markets are evolutionary institutions and, over time, they will be rational, but at any given day, any given moment, they could develop bubbles.  I do not see anything within this fact that weakens the case for libertarianism or contradicts it.

6 thoughts on “On Bubbles, Markets, and Libertarians

  1. This is from Scott’s post linked to here:

    >—“If they are irrational, then the case for government intervention is much stronger. Of course government intervention is also prone to errors, so market inefficiency doesn’t automatically make intervention desirable, but certainly the case for it is stronger.”

    He is not saying markets need “to be perfect to be the preferable option.” This is mostly a dispute about definitions and whether bubbles can be reliably identified before they pop. Scott is pointing out that – if they can be identified during the bubble – the case is stronger for a policy response than if they can’t be identified.

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    • Instead of calling markets efficient or inefficient, I would prefer to say that they tend toward efficiency. Perfect efficiency isn’t possible because perfect information isn’t available.

      This is mostly a dispute about definitions…

      I agree.

      …and whether bubbles can be reliably identified before they pop.

      It isn’t so much a matter of identifying a bubble, as it is identifying the causes and predicting the point at which it will burst. The first is relatively easy, the second is nearly impossible.

      Scott is pointing out that – if they can be identified during the bubble – the case is stronger for a policy response than if they can’t be identified.

      Exactly. A policy response requires identifying the causes of the bubble so they can be counteracted. If previously applied policies are among the causes of the bubble, then the correct policy response would be to repeal the offending policy or policies.

      For participants in, say, a housing bubble, it isn’t enough to know that a bubble exists, Investors, builders, buyers, and sellers may all realize or suspect a bubble exists, but as long as the incentives are there and prices keep rising, it is suicidal to stay on the sidelines while others reap fortunes, and it’s not irrational to participate, even knowing that the music will stop eventually and some (many) will be left without chairs.

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  2. Hi Ron,

    Maybe I didn’t search hard enough but I couldn’t find anything significant we disagreed about on this post.

    I’ve been away skiing a lot and I usually don’t take my computer when I go. So I may have been a bit less vigilant lately in correcting the usual errors by the usual suspects. Also I had been having some trouble posting here due to some glitches with WordPress and my own incompetence and laziness in dealing with tech issues. It seems like that’s fixed for now so I will try to improve my work ethic. Sometimes it can be exhausting correcting your errors.

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    • 🙂

      Lucky for you I haven’t posted anything here lately, so there’s nothing to correct. You might check some other blogs, though, I’ve been pretty prolific this last week. I’m sure you could find something with which to disagree.

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