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Noah Smith

Deflating a Bubble Before It Busts Would Be Huge

Economists are coming up with tools that just might do the job.

The chase tends to make matters worse.

The chase tends to make matters worse.

Photographer: Joe Klamar/AFP/Getty Images

Economists may be finally closing in on the reason for asset bubbles. How to pop them before they grow too large, however, is a much harder problem.  

The study of bubbles has steadily gathered urgency during the past four decades as crashes became more spectacular and more damaging. The stock crash of 1987 was a wake-up call for those who had assumed that markets function efficiently; there was no obvious reason why rational investors would suddenly conclude that U.S. companies were worth 23% less than the day before. The tech bubble was even more troubling because many observers had warned of a bubble for years before the crash, to no avail. The same thing happened with the housing bubble, only when that one burst it took the real economy with it — as tends to happen when rapid asset-price declines are combined with high levels of debt.