The Myth of Bubbles
Rather than summarize Kirchner's well-researched Policy Monograph, I can best give you a feel for his conclusions by quoting it directly:"The idea of 'bubbles' in asset prices quickly breaks down as soon as one tries to give it analytical coherence or empirical substance. Most commonly, the idea of a 'bubble' is little more than a tautology or circular argument."
Kirchner looks at theories of both rational and irrational bubbles, and finds them all lacking. In the process, he subjects the works Robert Shiller to withering critique:"Shiller's earlier work Irrational Exuberance was largely built around the observation of statistical mean reversion in equity prices, with the behavioural finance component tacked on in an effort to disguise the fact that he otherwise had nothing to say about the determination of asset prices."
In the process, Kirchner effectively defends the efficient market hypothesis (EMH) from behavioral critiques:"violations of the EMH are often misinterpreted as an argument against the allocative role of markets. In this respect, the EMH is analogous to the idea of perfect competition in markets for goods and services. No one believes that any real-world market for goods and services is perfectly competitive, and violations of the assumptions of the perfectly competitive model do not lead us to reject the model's usefulness or the role of markets in setting prices."
Continuing to quote Kirchner:"The behavioural finance and experimental economics literature questions the rational choice assumptions underpinning standard models of economic and financial behaviour. This literature is notable for failing to advance a generally applicable alternative behavioural model, but even if such a model were found, it might struggle to explain the irregular occurrence of 'bubbles.' Much of this literature relies on static experimental results divorced from real-world institutional settings. The irony of the behaviouralist literature is that it has no general behavioural model. Instead, this literature now serves mainly as a laundry list of actual or potential exceptions to the efficient markets hypothesis--to be ritually recited to either dismiss the role of markets as allocators of capital or to explain away market outcomes that do not conform with the prior beliefs of the analyst."
Kirchner continues with an excellent survey of"'Bubbles' as historical myth," which he wraps up with an account of Greenspan's policies, absolving Greenspan of responsibility for both the dot.com boom and the housing boom. Withal, his monograph merits close reading. With the added benefit that Kirchner favorably quotes David Henderson's and my Cato Briefing on Greenspan's monetary policies. :-)
Coda: Another economist who has recently risen to the defense of the efficient markets hypothesis is Scott Sumner, on his blog, "The Money Illusion." He points out an internal inconsistency in some behavioral critiques:"if investors are foolish to ignore the risk of Black Swan events, why should we trust probability values in anomaly studies?" More important, he offers a fundamental explanation for the housing boom that I have not seen elsewhere:"The housing bubble in 2004-2006 was partly driven by rapid immigration from Latin America (as was the bubble in Spain itself!), and also by a perception (which turned out false) that coastal zoning constraints were spreading into interior markets. Many Hispanic immigrants were snapping up older ranch houses, allowing native born Americans to move on to bigger McMansions. The immigration crackdown in 2007 dramatically slowed this immigration (as did the worsening economy.) Population growth estimates going several years forward fell sharply, hurting housing speculators. Ground zero of the sub-prime bust is in working class areas of the Southwest and Florida. Any guess as to who bought homes in those areas?"