So, my advice to Paul and Brad is this: don't start with a model that
focuses on investor beliefs about real economic variables. Instead,
start with a model in which financial firms use signaling to expand,
and the credibility of those signals increases over time as long as
nothing adverse happens. It should be easy to develop a model in which
signaling devices gain credibility slowly but lose credibility
suddenly. That will (a) produce the asymmetry between euphorias and
crashes and (b) tell a story that puts the fragility of the financial
sector in the middle, where it belongs.
Is it possible to lose even more respect for macroeconomics? They are truly at square one.
Seems redundant to explain why bubbles pop. If I remember correctly, Mason has done some research on this (remembers fondly participating in the ICES experiment).
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