What is Irrational Exuberance
Irrational exuberance refers to investor enthusiasm that drives asset prices up to levels that aren't supported by fundamentals. The term is believed to have been coined by Alan Greenspan in a 1996 speech, "The Challenge of Central Banking in a Democratic Society." The speech was given near the beginning of the 1990s dotcom bubble, a textbook example of irrational exuberance. "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?" asked Greenspan.
BREAKING DOWN Irrational Exuberance
Irrational exuberance is believed to be a problem because it gives rise to a bubble in asset prices. But when the bubble bursts, investors engage in panic selling, sometimes selling their assets for less than they're worth. The panic can also spread to other asset classes, and can even cause a recession.
Greenspan raised the question of whether central banks should address irrational exuberance via monetary policy. He believed that central should raise interest rates when it appears that a speculative bubble is beginning to take shape.
"Irrational Exuberance" is also the name of a 2000 book by economist Robert Shiller. The book analyzes the broader stock market boom that lasted from 1982 through the dotcom years. Shiller's book presents 12 factors that created this boom and suggests policy changes for better managing irrational exuberance. The book's second edition, published in 2005, warns of the housing bubble burst.