Posted by: CJ | March 27, 2010

I’ll take “Asset bubbles and friends I want to date” for $200

In Macroeconomics there’s a view of Federal Reserve policy jokingly referred to as “Punchbowlism”. It’s named after that idea that, as phrased by former Fed chair William McChesney Martin, the Fed should “to take away the punch bowl just as the party gets going.” He meant that the Fed should raise interest rates when inflation got out of hand, and could be used as a way of killing asset bubbles.

There are several problems with this approach. One is recognizing an asset bubble isn’t simple. Another is inflation targets are rather blunt economic tools. A good system of regulations would be preferable, but “regulatory capture”, where the people being regulated manage to find effectively permanent ways to dodge the regulations, is a major issue.

The macroeconomic situation above sounds, at least to me, somewhat like when I start becoming romantically interested in someone that’s already a good friend. It never ends well. I start to become closer to them as a friend due to my romantic interest. But, once I finally realize what I’m doing and why, it’s a little awkward to finally get around to asking the friend if they’re interested. And things generally go downhill from there, because wanting to date a close, close friend who’s not interested in you is just messy.

Ideally, you’d realize the situation you’re in before it becomes a problem, and distance yourself. But I have to realize what I’m doing soon enough and decide that I think it’s a problem. Neither are easy. Or I could have rules to make sure that I avoid such problems. But of course I’d break the rules, each time thinking it was “just this once”.

So I kinda think these two problems are similar. If economics could figure out how to spot and deal with bubbles, maybe that could be applied to saving friendships from romantic entanglements. On the other hand, since no good solution universal solution to the friendship/dating problem has been found, it could be that regulating banks to avoid asset bubbles is hopeless.

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