My understanding is that bubbles form when money is cheap and is chasing returns. If interest rates went up and/or the money supply was dampened and people had incentive to not chase returns in markets like tech, a bubble would be less likely to form.
That said, the psychology of bubbles is difficult to stop once it gains momentum.
The problem is that an entity like the fed doesn't have better information than the markets about appropriate asset pricing, so attempts to dampen bubbles might turn out to be premature or ill advised.
That's my $.02, I'm not a trained economist, just an armchair observer.
In a way, most economists are armchair observers. Economists don't have "practice" economies in which theories are testable -- we ARE the test dummies. It's unfortunate they run the same experiment over and over: http://en.wikipedia.org/wiki/Hyperinflation
Economics PhD applicants score almost as high in the quantitative component of the GRE as their counterparts in mathematics and physics. That's because math and statistics are crucial to modern economics.
You missed my point. I'm arguing theorizing around statistical data is only half the battle to the scientific equation. The other part is putting those theories to the test and quantifying the results in meaningful way over time. Again and again. Without the again-and-again part, you only have theoretical knowledge. Theoretical knowledge is not a "hard science". Involving data does not make a hard science. Applying heuristics to the data does not make it a science. A computerized model does not make something science. The weather-man uses science when developing a forecast. The forecast is not a hard science.
Take minimum wage for example. This is a theory with supporters in both camps - some for, some against. Well, how can we ever measure if a minimum wage is having a positive influence? How can we continue in support of a theory with no supporting evidence? Pile on 500 more concurrent theories, and you have a cluster-fuck only Krugman could defend.
Regarding the cheap money, isn't it better for markets to decide the interest rate rather than the Fed? Are there any examples in history where a country left the interest rate to be set by the market.
It's still the market that decides the interest rate. The Fed simply adjusts the money supply by buying or selling short term securities (historically) in order to create or soak up liquidity. The interest rate that results from these "Open Market transactions" are what you hear. The focus on short term securities means that in the long run the supply of money is still private-market driven.
There's an increased focus on affecting the medium-term or longer-term interest rates through the purchase of toxic assets like mortgage backed securities.
Not sure if that answers or clarifies anything though. I can say more if you're interested.
The key issue I find with these bubble's is that, once the bubble forms - the media / hype behind the bubble causes the bubble to grow.
The growth of the bubble makes many people rich and therefore, creates even more mass media / hype about the 'bubble'.
This final stage makes everyone who is outside the bubble, wish they could get in on the 'action' of the bubble. People invest at any price, valuations continue to rise way past a realistic point and the whole thing is destined for failure.
When the first cracks emerge and the price proves to not support the reality of investment the whole things begins to tumble down.
I personally don't blame the people in the bubble initially for the collapse, but rather the media for driving the bubble's growth outside of the bubble's expertise.
If there is financial incentive to keep the growth of the bubble going isn't it in the interest of first movers to influence the markets by feeding media with "get rich quick" stories.
