Using the federal funds rate to deflate asset bubbles is like bringing a thermonuclear weapon to a knife fight. Unemployment following the official end of the 2001 recession peaked in 2003. Raising rates sooner and more aggressively to deflate the housing bubble seems more likely to have simply further dampened the growth in hourly earnings for large groups of workers.

Would it not be more appropriate to attack asset bubbles with tools aimed directly at those particular markets? For instance Dean Baker has revived the idea of stock transfer tax (http://www.nytimes.com/2008/12/14/magazine/14Ideas-section4-t-005.html).

Novel research shows that experienced investors under novel investment scenarios (think: derivatives) are not immune from bubbles.

Is novelty (for all its advantages) part of the culprit here?

So, I still wonder whether the equilibrium here isn't federal regulators as "crazy person" who might drastically tighten leverage requirements at any moment, perhaps only for the specific novel asset class.

Then to avoid the risk of falling prey to the "crazy person" you only do things that will make you money long term; i.e., value the asset properly.

All an automatic mechanism will do is to move bubbles somewhere else. There will always be some sector or some instrument that's not covered by the measurements that feed into the automatic stabilizer (or that's covered in the wrong way, with the wrong coefficient). And if there's not, some bright kid in the back room will invent one, because markets as presently constituted want to have bubbles. They're extremely profitable for the people who run markets, at least for the short-to-medium term. And that's long enough for careers to be made and yachts to be bought.

One thing that might be useful would be some kind of mandatory escrow for bonuses and options -- 5 or 10 years to see how things shake out. Sure, there would be lots of complains about how that would dilute the incentives for people to do great deals, but that's the point.

First: take economics away from economists. There are a few good ones but on average economists are too beholden to dogmatic idiocy and group-think.

Second: "it's the unemployment, stupid!"

(From IRA STEWARD ON CONSUMPTION AND UNEMPLOYMENT by Dorothy W. Douglas, 1932)

Now machinery is only a blessing "provided the wealth more rapidly produced is consumed as fast as days' works are destroyed ... but if this blessing is to continue to bless, wages must continue to rise. If wages stop rising, machinery stops blessing." Ultimately "production gains upon consumption." That is the underlying fact. "Wealth is more rapidly produced than consumed in the leading nations … This fact combined with the poverty and misery of the rest of mankind [outside the charmed circle] is the mainspring of enforced idleness [within it]. And enforced idleness is the real secret of the financial convulsions and bankruptcy which from time to time sweep over the most prosperous countries of the civilized world." The capitalists are unmindful of the first danger signals, the beginnings of a redundant labor supply. Tacitly they assume that a little surplus labor is good for business. "They do not want the number of unemployed so large as to occasion inconvenience or the scandal of starvation, but they are quite alike in the unexpressed wish that the number of unemployed shall be so large that those employed shall have as little power as possible to dictate the terms of their employment." This is especially their attitude at a time when wages are rising and business is still brisk.

But "when the first laborer is discharged, he stops buying." And from then on his powers for evil multiply indefinitely. Then begins "the deadly but natural competition existing between those who are employed and those who are not." "An unemployed man is the most deadly fact that exists outside of a graveyard. He is the source of all that is bad ... . Without raising his hand, he takes far more bread from others than he himself can eat .... more clothes than he can ever wear .... more opportunities than he alone could improve."

He makes his fellows, who are still at work, willing to work for longer hours ("... the deadly competition between those who have nothing to do and those who do too much for fear of doing nothing") as well as lower wages ("Discharges must occur first, before wages can fall to any appreciable or serious extent"); and besides, he makes them afraid to spend what little they have. "The most cautious and calculating laborers, who are not themselves discharged, are sufficiently alarmed by the first few discharges that occur about them to wait before buying ... Meanwhile the individual employer is helpless to stem the tide. "The capitalist is forced to discharge today, for the blunders of his class five or ten years ago.'"

Third: "It's the unemployment, stupid!" (see #2 above). The sentence, "tacitly they assume that a little surplus labor is good for business" could sum up the attitude of economists enraptured over the past three decades by the NAIRU dogma.

So which bubble do you want to target? How would you create a bubble index? Someone other than the fed needs to worry about stock bubbles. Some one else the housing bubble in California. Someone else to non-bubble in Utah. Mark, have you simulated this and what is your history about warning of bubbles? Maybe we should have a bubble panel with people like Mark, Shiller, Krugman, Bernanke, someone from S&P, etc. (Those names except Shiller just came without much thought.) They could at least warn the public. Or maybe NBER should weigh in of bubbles but not call them 9 months after they burst. If markets were rational we would not have big bubbles and maybe some rational guidance from non-market participants could add rationality without a direct link to the funds rate. We need some way to keep them off the bubbly!

Maybe there is a cyclical swing between the predatory and the more "responsible". In other words the setting for a more modest profit-taking on any side may depend on factors beyond the purview of economics.

So thought Veblen?

The following is drawn from The Instinct of Workmanship and the Irksomeness of Labor
by Thorstein Veblen American Journal of Sociology
volume 4 (1898-99)

"The history of mankind, as conventionally written, has been a narrative of predatory
exploits, and this history is not commonly felt to be one-sided or misinformed. And a sportsmanlike inclination to warfare is
also to be found in nearly all modern communities. Similarly, the sense of honor, so-called, whether it is individual or national
honor, is also an expression of sportsmanship. The prevalence of notions of honor may, therefore, be taken as evidence going in
the same direction. And as if to further fortify the claim of sportsmanship to antiquity and prescriptive standing, the sense of honor is also noticeably more vivid in communities of a
somewhat more archaic culture than our own.

"Yet there is a considerable body of evidence, both from cultural history and from the present-day phenomena of human life, which traverses this conventionally accepted view that
makes man generically a sportsman. Obscurely but persistently, throughout the history of human culture, the great body of the people have almost everywhere, in their everyday life, been at
work to turn things to human use. The proximate aim of all industrial improvement has been the better performance of some workmanlike task. Necessarily this work has, on the one hand,
proceeded on the basis of an appreciative interest in the work to be done; for there is no other ground on which to obtain anything
better than the aimless performance of a task. And necessarily also, on the other hand, the discipline of work has acted to develop a workmanlike attitude. It will not do to say that the work accomplished is entirely due to compulsion under a predatory regime, for the most striking advances in this respect have been
wrought where the coercive force of a sportsmanlike exploitation has been least."

I think we need to think more broadly about bubbles. After all they have been rather rare events in history, tulips, the Credit Mobilier, U. S. housing in the 2000's. If you think about it we have a small shock to the system that has enormous effects. The propagation mechanism turns a small shock into a massive storm. The numbers I have seen have foreclosures rising from about 1 percent of all mortgages to 2.5% true it more than doubled but still in terms of scale it seems very small. On the other hand it ends up bringing down the largest financial system in the world. It therefore must mean that the system was unstable given that a small shock could topple it. It could actually mean that the Fed was right about not pricking bubbles if the effects of bubbles are actually small shocks to a stable system. Let's assess, first, the magnitude of the shock and then its effect. Large shock versus stable system or small shock versus unstable system. Its easy to trace how these mortgages were pyramided into bonds and stocks and propagated the shock. Why not go back to a basic point that we had developed an inherently unstable financial system that is now broken. And we need to put that back together. And that is something that the private sector cannot do.