01 Mar 2016

Efficient Market Bubbles and Why Is Scott Sumner a Libertarian?

Libertarianism, Scott Sumner 18 Comments

I am really swamped with work stuff so I can’t do this justice. But I couldn’t ignore this recent Scott Sumner post at EconLog, in which he asks, “If you believe in bubbles, then why are you a libertarian?” Here’s his argument:

I don’t believe in bubbles. In addition, I’m a libertarian. I see those two facts as being related. If asset markets are efficient, then the case for government intervention is weaker…

Here’s what I don’t understand. I often talk to libertarians who seem to see bubbles all over the place. But this implies that markets are not pricing assets at the proper level. Often this will be attributed to outside factors such as monetary policy. It would be like excusing inefficiency in soybean pricing by pointing to the fact that it was windy and rainy last week…

If markets are not efficient when monetary policy is off course, there is absolutely no reason to assume that [markets] would be efficient when monetary policy is not off course. Inefficiency results from irrational pricing, it’s either a problem or it isn’t. People don’t become irrational just because the fed funds rate is set at 2% rather than 3%. Either markets are irrational or they aren’t.

If they are irrational, then the case for government intervention is much stronger.

For brevity I took out some of his caveats and nuances, but that’s definitely his argument. Here are some responses:

==> The most obvious one, which people in the comments harped on, is that government regulators are no more likely to get it right than private investors. However, even though it’s important to make that point, I think it doesn’t take on Scott’s argument directly. He actually acknowledges that point, and claims he just means that the case for markets surely is weaker if we admit markets are often prone to bubbles.

==> Why does Scott continually claim that efficient markets would rule out bubbles? At NYU we studied formal models–where all the agents obeyed Bayes’ Law and had rational expectations in Lucas’ sense–where there could be “informational cascades” and thus herd behavior. The intuition is that people have private signals that are noisy, and they observe other people’s actions to gain more information. If it just so happens that the first few people get a “buy” signal even though the asset is a dud, then each subsequent agent–even though most of them will get a “don’t buy” signal–will look at the string of buyers and conclude that his or her own signal is faulty. So you can get a whole population buying an asset even though if you polled them, collectively their aggregate information knows that the asset is a dud.

Extending that idea, I never published it but I wrote up a model one time dealing with the popular “rational expectations” objection to Austrian business cycle theory. If you view market prices as providing noisy information to investors, and if you think the Fed intervening will make the signal noisier–even though investors act perfectly rationally to compensate for Fed policy–then it is pretty straightforward to build a Chicago-Approved model where you get more booms over a period of time with Fed intervention.

==> There is a whole tradition in classical liberalism and modern libertarianism of people who actually believe humans have natural rights, and that it is immoral to violate someone’s rights. Not everyone is a crude utilitarian.

==> I wonder too why someone who is in favor of a carbon tax (can’t find good link but he is), 80% consumption tax rates on rich people, who thinks that if Republicans delayed a 40% surtax on employers who offer expensive health insurance policies it proves they don’t like poor people, who really wants to be able to support a federal Guaranteed Annual Income but just can’t get the numbers to work, who jokingly refers to his preferred policies as debasing the currency, and who proposes a single-payer health care system for catastrophic medical expenses…calls himself a libertarian? Seems to be a lot more strikes than someone who believes asset prices can be in a bubble when the Fed floods the markets with trillions of dollars.

18 Responses to “Efficient Market Bubbles and Why Is Scott Sumner a Libertarian?”

  1. Levi Russell says:

    Clearly Scott has not absorbed Demsetz’s 1969 article entitled “Information and Efficiency: Another Viewpoint.”

    • Major.Freedom says:


      No laissez faire advocate claims that the free market is a perfect method that prevents individuals from making calculation errors.

      The champions of government intervention, including Sumner, base their entire worldview on the Nirvana fallacy and like slave owners who despise the fact that their slaves just can’t take care of themselves “ideally” and “perfectly”, that this is sufficient justification to keep them enslaved. And, those who argue for maximum efficiency and morality through slave emancipation are clearly presuming far too much, that they won’t be able to achieve perfection through emancipation. That assumption is false, so… keep the slavery intact!

      It is the same thing with central banking. The argument isn’t that people will never make calculation errors in a free market without central banking. It is just that comparatively speaking, the free market process is the best way to solve whatever problems arise, including problems that arise in the free market process itself. This is the meaning of the rather poorly worded concept of “self-correction”. People are rational in the sense of purposefully seeking gains and purposefully avoiding losses. Whatever problems arise, individual minds are the only means by which problems can be solved.

      There is nothing wrong with wanting to help people, but the problem with Socialists like Sumner is that they want to destroy the ability of individuals to use their reason to solve their problems. He wants to substitute other people’s individual ideas and plans with his own ideas and plans, by force. He looks down on the average individual as metaphysically unfit to manage his own affairs. It doesn’t matter if the average person today is 100 times more intelligent than the average person 500 years ago. The fact they are relatively unintelligent, repulses him to such a degree that it is used as rationalization for the state power being used to exploit for the benefit of those in the state and their special interest groups.

      Another factor to always keep in mind is the chronic inability of Socialists to distinguish between aggression and non-aggression. This comment:

      “I often talk to libertarians who seem to see bubbles all over the place. But this implies that markets are not pricing assets at the proper level.”

      is proof Sumner is unable to distinguish them.

      He and other anti-capitslists call what we have now a “market.” That this “market” process is being argued by libertarians as “not pricing assets at the proper level”. First, we do not have a free market in money, and that is what is making it impossible for investors to learn from any pricing errors until it is too late, that is, when the real side of the economy becomes distorted to such a degree that physical reality reasserts its determinism, which then manifests in a combined real and nominal “shock”. Second, to blame the market process as not to blame the market without a central bank. Sumner admits this unintentionally when he presents what he thinks is an exhaustive alternative:

      “If markets are not efficient when monetary policy is off course, there is absolutely no reason to assume that [markets] would be efficient when monetary policy is not off course”.

      Quite right! Markets with central banks are not efficient when monetary policy is either off course or on course, because markets with central banks are not efficient period. There is no on course or off course with central banks. Sumner just believes there is because he is only trying to convince himself indirectly that his ideal plan is “on course monetary policy.” Call it on course or off course, to Austrians it doesn’t matter, because there can be no on course monetary policy. All monetary policy is “off course.” There is no socialist course that can avoid malinvestment. The free market process requires a free market in money.

  2. DZ says:

    I’ve never interpreted from Austrian theory the idea that bubbles could never form in a free-market. Prices change all the time for various competitive and external reasons, and the prices of goods/assets will be above or below the “equilibrium” price at any given moment. The more prices “bubble,” the more indicators there are for market participants to begin to correct that bubble just through self-interest. Like an arbitrageur in securities markets. Correction periods are naturally going to be longer or shorter for different markets. Ultimately it is the combination of incentives and market indicators which allow for markets to correct. Thus, if government perturbs one of these two, then markets would no longer have any way of rationally correcting. It’s like negatively manipulating food labels for someone trying to purchase the healthiest meal with the intention of driving up gym memberships, and then when food labels are corrected and working diets cause many recently built gyms to become obsolete blaming the free market for the gym failures and unemployed personal trainers. How _could_ markets ever be even somewhat efficient without meaningful information inputs. The market can create bubbles, but the government sustains them.

    Any discussion on rational expectations and bubbles as it pertains to ABCT should be accompanied by this article:


    Working in valuation and investment banking, it’s easy to see how taxes, interest rates, regulatory burden, and a monetary “put” mentality impact incentives. It seems every time rates plummet, junk bond rates follow, M&A activity and pricing-multiples sky-rocket, and debt holdings are enlarged. Money pours into private equity and competitive venture valuations become laughable. It’s happening now and it’s happened several times before.

    • Bob Roddis says:

      Thanks for the link. That’s a very good article.

    • guest says:

      “The market can create bubbles, but the government sustains them.”

      Precisely right.

      The essense of false booms is that producers are producing for demand that won’t materialize. The logical consequence for unsustainable production is a bust.

      That can happen to any business, at any time.

      Monetary inflation makes false booms systemic because so many businesses can be affected by the resulting artificially low interest rates at one time.

      • Guest says:

        I would go 1 step further and say artificially low interest rates does indeed create bubbles not just sustain them. Bankers get their bad ideas from somewhere.

        Junior banker :”What should we do with all this cheap money?”

        Senior banker” ” Don’t touch it!”

        Junior banker : ” I just cant resist”

        Senior banker: ” If you insist, let me show you the way we do this.”

  3. Guest says:

    Central bank control of interest rate makes market inefficient. I am Libertarian in Chief!

  4. Khodge says:

    Good post but I’m intrigued by the possibility of convincing you that I believe in a carbon tax (or whatever subject comes along) without leaving a paper trail. Think of the havoc Prof. Krugman could wreak in such a scenario.

  5. Tel says:

    Here’s what I don’t understand. I often talk to libertarians who seem to see bubbles all over the place. But this implies that markets are not pricing assets at the proper level.

    Only if you believe that a free market can continue unimpeded regardless of the many and varied forms of government intervention. But if you believe that, then libertarians should be happy to have any government policy, because the market will always correct itself. Indeed, it makes you wonder why some nations are rich and some are poor, once you believe that governance is irrelevant.

    Often this will be attributed to outside factors such as monetary policy. It would be like excusing inefficiency in soybean pricing by pointing to the fact that it was windy and rainy last week…

    Well monetary policy is one type of government interference. When there’s a storm that destroys a crop, we do often see a price jump, at least for a while. When the Fed makes a sudden and unexpected change in policy, other prices (e.g. stock market or asset prices) will react to that, so I don’t think it’s so very different.

    To the extent that the Fed can fool people into believing that they are significantly wealthier than they really are, they might consume more than they otherwise would. So in terms of “excusing inefficiency” are we to presume that the inefficient people are the ones who ARE fooled by the Fed (i.e. those who follow government instructions) or are we to presume the inefficient people are the ones who DON’T follow instructions and who think the Fed is up to no good? Who is wrong here?

    If you define “efficient” as whoever makes the biggest profit, that would be the people who ride the boom on the way up, then step off at the right moment in order to avoid the crash… but it’s clearly impossible for everyone to profit the same way. So if you want to look at efficiency of the system as a whole, you can’t measure it like that. Once you are left with something you can’t measure in any objective way, all you have is “I don’t like that!”

  6. Andrew_FL says:

    Sumner is not a libertarian. He’s a mildly market oriented leftist. Here we see the problem with the 3 second libertarian pitch: “Social Liberal, Fiscal Conservative.”

    Well, one of the problems with the three second pitch.

    • Levi Russell says:

      Great point, Andrew_FL. I thought your comment on Sumner’s post was the first to get to the root of the problem.

      • Andrew_FL says:

        Thanks, Levi. I have to say I was heartened to see people who understood my point. I expected some push back but I guess people either got it or thought it made no sense without further explanation and didn’t bother to engage.

        I’ve been pretty busy lately so haven’t had much time to play lurking econ gadfly, but seeing what mischief Sumner et al get up to in my absence perhaps I should move up my plans to finally get a blog going.

        • Levi Russell says:


          If you don’t want to go to the trouble of starting your own blog, I’m always looking for guest contributors or regular contributors to join the Farmer Hayek blog. It’s primarily focused on the economics of agriculture, food, rural America, and natural resources, but I often have posts that are more theoretical or on an ol’ topic that comes around. Please contact me at the link above if you’re interested.

  7. Ray Lopez says:

    In addition to the excellent points made by the author (“herd behavior”) you must take issue with Sumner’s definition of “bubble”. He claims there’s no bubble if, sometime in the future, prices return to former highs. But this is absurd since at the time a price collapses, due to lack of demand, it’s impossible for people to know whether or not the price will come back in a short time or in a long time. Hence the damaging uncertainty of bubbles. Finally, money is largely neutral (Google Ben S. Bernanke, FAVAR) and thus Sumner’s mentioning of monetarism and Fed policy is irrelevant.

    • Major.Freedom says:

      Largely neutral means non-neutral.

  8. Transformer says:

    “Why does Scott continually claim that efficient markets would rule out bubbles?”

    Wouldn’t a market with a bubble be inefficient by definition ? The models that Bob studied at NYU look to me like sophisticated explanations of why markets may have bubbles, rather than an explanations of why these bubbles might represent market efficiency.

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