The History and Economics of Stock Market Crashes
Introduction (Via CFA)
The phrase “irrational exuberance” is closely associated with Alan Greenspan, the former chairman of the U.S. Federal Reserve Board. As Shiller (2005) explains:
[Greenspan] used [it] in a black-tie dinner speech entitled “The Challenge of Central Banking in a Democratic Society” before the American Enterprise Institute at the Washington Hilton Hotel [on] December 5, 1996. Fourteen pages into this long speech, which was televised live on C-SPAN, he posed a rhetorical question: “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?” He added that, “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.” Immediately after he said this, the Tokyo stock market, which was open as he gave this speech, fell sharply, closing down 3%. Hong Kong fell 3%. Then markets in Frankfurt and London fell 4%. The stock market in the US fell 2% at the open of trade.
Shiller goes on to explain:
It appears that “irrational exuberance” are Greenspan’s own words, and not a speech writer’s. In his 2007 autobiography, The Age of Turbulence: Adventures in a New World Greenspan said “The concept of irrational exuberance came to me in the bathtub one morning as I was writing a speech.” (p. 176)
Although it is unlikely that Greenspan’s simple statement was intended to cause the reaction that it did, the term “irrational exuberance” has now become associated with any period when investors are in a heightened state of speculative fervor. Speculative fervors, or bubbles as they are more popularly known, may be easy to identify with the benefit of hindsight, but they are not nearly as easy to identify when they are occurring. Moreover, they are not by any means a new phenomenon. Even though the recent market crash beginning in 2007 is likely fresh on the mind of the reader, there have been many others, and far worse—for example, from August 1929 to May 1932, when the U.S. stock market fell 79 percent, and from December 1989 to March 2003, when the Japanese stock market fell nearly 72 percent. (These returns are real total returns; in other words, they include dividends and are adjusted for the effects of consumer price inflation or deflation.1)