What does “irrational exuberance” mean?

Irrational Exuberance is when investors are so excited about an asset that they drive up its price more than its facts justify. Greenspan, chair of the Fed from 1989 to 1996, made the phrase famous in a speech called “The Challenge of Central Banking in a Democratic Society.”The speech was made near the start of the dot-com bubble in the 1990s, which is a classic case of irrational optimism:

“But how do we know when irrational optimism has caused asset prices to rise too high, causing them to drop unexpectedly and for a long time, as happened in Japan over the past ten years?” What role does that opinion play in monetary policy?”

Cracking Down on Irrational Joy

A lot of people are feeling irrational and overly optimistic about the economy. When buyers think that the recent rise in prices can tell them what will happen in the future, they act as if the market is entirely stable, making prices go up even more.

People think it’s a problem because it can cause asset prices to bubble. When the bubble finally pops, buyers sell quickly out of fear, sometimes for less than what their assets are worth. When a bubble pops, fear can spread to other assets and even start a recession. The investors who are still all-in right before the downturn are the ones who get hurt the most. These are the investors who are too sure that the bull run will last forever. You will surely get gored if you think a bull won’t turn on you.

Alan Greenspan asked if central banks should deal with irrational optimism by causing interest rates to be too low ahead of time. It seemed to him that the central bank should raise interest rates when it looked like a speculative bubble was starting to form.

The dot-com bubble in the late 1990s is an example.

Fed Chair Alan Greenspan told the markets on December 5, 1996, that they were getting too excited for no reason. 1 But he didn’t tighten monetary policy until the spring of 2000. By then, banks and brokerages had already bought internet stocks with the extra cash the Fed had made available before the Y2K bug. Greenspan had to pop the bubble because he had added fuel to the fire.

The next stock market crash wiped out more than four years of gains in the tech-heavy Nasdaq composite index and a market value of many billions of dollars.

The Book of Irrational Exuberance

Irrational Exuberance is also a book that economist Robert Shiller wrote in 2000. The book looks at the stock market boom from 1982 to the dot-com years. In his book, Shiller lists 12 things that led to this boom and offers changes to policy that could help deal with irrational Exuberance better. The second version of the book, which came out in 2005, warns of the housing bubble burst that happened in 2008 and caused the Great Recession.

Conclusion

• Irrational Exuberance is when the market is overly optimistic for no good reason. It is not based on fundamental valuation but on psychological factors.
• In 1996, Alan Greenspan, chair of the Federal Reserve, used the phrase extensively when discussing the growing internet bubble in the stock market.
• People’s irrational excitement is often linked to asset prices increasing too quickly, known as a bubble. When a bubble pops, it can cause market fear.