Knowing and Making

Lots of behavioural finance conversations going on on the blogs today and yesterday. Chris Dillow of Stumbling and Mumbing replies to my proposal for governments to take into account cognitive bias while regulating. Simon Johnson of Baseline Scenario responds to a debate between Richard Thaler and Richard Posner about financial regulation. Alex Tabarrok from Marginal Revolution highlights the difficulty of fighting asset bubbles , even if you have overcome the challenge of identifying them . Kenneth Arrow (via Conor Clarke of The Atlantic) argues that behavioural economics doesn't predict anything . Update : A friend points out this letter in the FT from John Maule calling for behavioural approaches to be used more in regulation and investment decisions. I'd love to have time to engage in depth with all of these debates, but let me start with a couple of key points. Commenters on both Chris's and Simon's posts use a familiar argument to dissent from the idea of beh...

Pointing out a speech by William C. Dudley, president of the New York Fed, Simon Johnson says : Dudley says that the Fed can pop or prevent asset bubbles from developing. This would represent a major change in the nature of American (and G7) central banking. It’s a huge statement - throwing the Greenspan years out of the door, without ceremony. It’s also an attractive idea. But how will the Fed actually implement? Senior Fed officials in 2007 and 2008 were quite clear that there is no technology that would allow them to "sniff" bubbles accurately - and this was in the face of a housing bubble that, in retrospect, Dudley says was obvious. But is that true? If we define a bubble as "overvaluation of assets relative to their future returns" then to spot one, we would need to compare asset prices with future returns. But although asset prices are measurable, future returns are not - and this is why people generally think that bubbles are unspottable. We wouldn't...