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Irrational Exuberance - Friday, August 18, 2006

"Irrational exuberance" is a phrase used by former Federal Reserve Board Chairman Alan Greenspan in a speech given at the American Enterprise Institute during the stock market boom of the 1990s. The phrase was interpreted by financial pundits as a typically cryptic warning that the market might be overvalued.

Although it is sometimes believed that Greenspan's comment was made near the height of the dot-com boom (and contributed to its downfall), it was actually said much earlier, in December 1996 (emphasis added in excerpt):

(…) Clearly, sustained low inflation implies less uncertainty about the future, and lower risk premiums imply higher prices of stocks and other earning assets. We can see that in the inverse relationship exhibited by price/earnings ratios and the rate of inflation in the past. But how do we know when irrational exuberance has unduly escalated asset values, which then become subject to unexpected and prolonged contractions as they have in Japan over the past decade? (…)
("The Challenge of Central Banking in a Democratic Society", December 5, 1996)

The presence of the short comment—never repeated by Greenspan since—within a rather dry and complex speech would not normally have been so memorable; however it was followed by immediate slumps in stock markets worldwide, provoking a strong reaction in financial circles and making its way into common parlance.

The losses were quickly recouped and eclipsed by the accelerating stock market boom; Greenspan's comment was well remembered although few heeded the "warning." The phrase was notably used by Yale professor Robert Shiller, who named his book after it in 2000. When the market slumped in the same year, in response to increasing interest rates, the phrase got another popularity boost and was much used in hindsight, to characterize the excesses of the bygone era. In 2005, upon Greenspan's retirement from the Treasury Board, The Daily Show with Jon Stewart held a full-length farewell show in his honor. The show featured the moniker "An Irrationally Exuberant Tribute to Alan Greenspan".

It had become a catch phrase of the boom to such an extent that, during the economic recession that followed the stock market collapse of 2000, bumper stickers reading "I want to be irrationally exuberant again" were sighted in Silicon Valley and elsewhere.
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