Markets: The Good, the Volatile and the Sometimes Ugly
Unsustainable expansion followed by a devastating collapse in the US economy helped to stimulate important new research revisiting the original supply and demand commodity-flow experiments at Purdue. The motivation came from the large subsequent literature on assets market experiments showing the robust tendency for inexperienced subjects to generate price bubbles on the slow pathway to an experience-based rational expectations equilibrium. What accounts for the enormous stability and efficiency in the first kind on market, and the contrasting instability in the second? Moreover, the parallels in the national economy were striking: non-durable consumer goods and services markets are seventy-five percent of private product, and a rock of stability; the other twenty-five percent of durable goods, in particular housing, is a recurrent source of instability. New experiments demonstrated that re-trade-ability is at the core of accounting for the performance difference, with the poorer performance of markets for durables worsened by easy cash availability. In the economy, the latter is well represented by housing prices fueled by excess inflows of mortgage credit.