Happy Birthday Irrational Exuberance

It was 10 years ago today that Alan Greenspan made his famous “irrational exuberance” speech. Here’s the money paragraph:

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? And how do we factor that assessment into monetary policy? We as central bankers need not be concerned if a collapsing financial asset bubble does not threaten to impair the real economy, its production, jobs, and price stability. Indeed, the sharp stock market break of 1987 had few negative consequences for the economy. But we should not underestimate or become complacent about the complexity of the interactions of asset markets and the economy. Thus, evaluating shifts in balance sheets generally, and in asset prices particularly, must be an integral part of the development of monetary policy.

It doesn’t seem that dramatic, but at the time, it was taken very seriously. The next day, the Dow dropped 55 points. Since then, the market has more than doubled. The S&P 500 has gone up about 90%, plus there’s another 17% from dividends. Inflation is up about 28%.

Posted by on December 5th, 2006 at 10:22 am


The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.