Irrational Exuberance Turns Ten

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Yes. That’s how long it’s been since Alan Greenspan sent the markets tumbling with his mention of “irrational exuberance” (a tip of our hats to Eddy Elfenbein for the reminder).
Here are the words that sent panic waves through the hearts of many:

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.
That’s it. We didn’tremember that it was phrased so mildly, and even put in the form of a question. At the time it didn't seem mild. In fact, in 1996 it came as something of a shock. Of course, it was a temporary shock and we remained exuberant for a least a few years more, in part because despite the talk of irrationality the Fed didn’t do very much to restore rationality.

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