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Irrational Exuberance

Reviewed by Vineeth | Updated on Sep 30, 2020

Catalogue

Introduction

Irrational exuberance points to the enthusiasm of investors that makes asset prices shoot up to prices that are not backed by the fundamentals.

It is believed that the term 'irrational exuberance' was coined by Alan Greenspan in the year 1996 in his speech 'the challenge of central banking in a democratic society'. The speech was delivered in the 1990s dot-com bubble, which is a good example of irrational exuberance.

Greenspan went on to ask as to how are they supposed to know when an irrational exuberance scenario has inappropriately made the prices of assets shoot up which will then go onto being a subject to contractions that are unanticipated and prolonged like they have observed in Japan over the last ten years. He also asked how they can factor that analysis in monetary policies.

Understanding Irrational Exuberance

Irrational exuberance is perceived as a problem as it results in asset prices shooting up. This is referred to as a bubble in the asset price. However, when the bubble bursts, investors tend to press the panic button and go on to a selling zone.

They may also sell their assets at a much lower price than they actually are. The panic can be such that it can spread to other classes of asset and can result in a recession.

How to Check Irrational Exuberance?

Greenspan came up with the question if the central bank can address irrational exuberance through its monetary policies. He feels that the central bank can increase the interest rate when it seems like an uncertain bubble is taking its shape.

Robert Shiller, a famous economist, wrote a book 'Irrational Exuberance' in the year 2000. His book analyses the overall rise in the stock market since the year 1982 till the dot-com years. The book provides 12 factors that are responsible for the boom in the stock markets. Also, it gives changes in the policy which can manage irrational exuberance better.

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