What it is:
The phrase irrational exuberance was coined by Alan Greenspan, chairman of the Federal Reserve, in a December 5, 1996, speech to the American Enterprise Institute. In the speech, Greenspan asked, “How do we know when irrational exuberance has unduly escalated asset values which then become the subject of unexpected and prolonged contractions as they have in Japan over the past decade? And how do we factor that assessment into monetary policy?”
How it works (Example):
According to Yale’s Robert J. Shiller, author of the book Irrational Exuberance, which expands on the theme of Greenspan’s comments, the term is now used to describe “a heightened state of speculative fervor."
Why it Matters:
This term is more famous for its impact rather than for its definition. Greenspan’s speech was televised, and many traders around the world immediately interpreted the comments as an opinion that U.S. markets were overvalued and that the Federal Reserve might raise interest rates. As a result, the Japanese stock market, which was the first major market to open after Greenspan’s evening speech, fell 3.2% in one day. The Hong Kong market fell 3%; Germany’s market fell 4%; and prices on the London exchange fell 2%. When the New York Stock Exchange finally opened, the Dow Jones Industrial Average fell 145 points within 30 minutes, although the market closed down only 55 points for the day.
There is considerable speculation to this day about whether Greenspan’s rhetorical question about market overvaluation was actually a statement of his own opinion and thus a hint at coming Federal Reserve actions. This was not the first (or last) time that traders speculated on the true meaning of Greenspan’s words, but irrational exuberance is perhaps one of the most famous symbols of the influence Alan Greenspan and the Federal Reserve have on domestic and international markets.