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? Markets around the world followed. Origin of the phrase[ edit ] Greenspan wrote in his book that the phrase occurred to him in the bathtub while he was writing a speech. The speech coincided with the rise of dedicated financial TV channels around the world that would broadcast his comments live, such as CNBC. The further irony was that if it was indeed his intended purpose to "talk markets down" he was later ignored as stock valuations three years later dwarfed the levels at the time of the speech.
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Irrational exuberance refers to extreme investor enthusiasm that drives asset prices up to and beyond levels that are not supported by fundamentals. And how do we factor that assessment into monetary policy? The term was popularized by former Fed chairman Alan Greenspan in a speech addressing the burgeoning internet bubble in the stock market.
Irrational exuberance has become synonymous with the creation of inflated asset prices associated with bubbles, which ultimately pop and can lead to market panic. Breaking down Irrational Exuberance Irrational exuberance is widespread and undue economic optimism. When investors start believing that the rise in prices in the recent past predicts the future, they are acting as if there is no uncertainty in the market, causing a positive feedback loop of ever-higher prices.
It is believed to be a problem because it can give rise to bubbles in asset prices. The panic that follows a bubble can spread to other asset classes, and can even cause a recession. Alan Greenspan raised the question of whether central banks should address irrational exuberance via a preemptive tight monetary policy. He believed that central should raise interest rates when it appears that a speculative bubble is beginning to take shape.
Having poured gasoline on the fire, Greenspan had no choice but to burst the bubble. By the end of , most dot-com stocks had gone bust. It would take 15 years for the Nasdaq to regain its dot-com peak, which it did on 23 April The book analyzes the broader stock market boom that lasted from through the dotcom years.