For several years now, a few smart people–Morgan Stanley’s Stephen Roach is the first to spring to mind, but there were others–have been arguing that the Federal Reserve ought to do more to rein in the creation of asset price bubbles. Alan Greenspan, after making a tentative attempt at bubble management with his famous “irrational exuberance” speech in December 1996, decided that it was just too hard to differentiate a bubble from perfectly rational exuberance until after it had burst, so the Fed should stick to cleaning up messes. As he said in 2002:
If the bursting of an asset bubble creates economic dislocation, then preventing bubbles might seem an attractive goal. But whether incipient bubbles can be detected in real time and whether, once detected, they can be defused without inadvertently precipitating still greater adverse consequences for the economy remain in doubt.
Anyway, it’s a familiar debate–and one that’s going to continue. Ben Bernanke has even made some noises lately about maybe reconsidering the Greenspan stance.
What I didn’t realize until yesterday, though, was how long the debate has been going on. John Maynard Keynes explicitly addressed all these arguments in 1936 in chapter 22 of his General Theory (I’ve read Chapter 12 about 10 times, but apparently never got to Chapter 22). He wrote at length about those who thought the Fed and other central banks should have nipped the late-1920s boom in the bud with tighter monetary policy, and concluded that they were all wet:
The right remedy for the trade cycle is not be found in abolishing booms and thus keeping us permanently in a semi-slump; but in abolishing slumps and thus keeping us permanently in a quasi-boom.
My column this week is probably going to be about how we’re all Keynesians now. In terms of supporting economic stimulus from Washington in dire times like these, I guess that’s true. But as far as bubble- management goes, the Keynesian view looks like it’s going to come in for a lot of flak in the years to come.