Friday saw a blowout jobs report.
But Friday, or rather December 5, is a momentous day in the history of monetary policy.
On this day in 1996, then-Federal Reserve chairman Alan Greenspan made his famous speech wherein he asked if “irrational exuberance” had begun to play a role in the increase of certain asset prices.
Here’s the key quote from Greenspan:
Clearly, sustained low inflation implies less uncertainty about the future, and lower risk premiums imply higher prices of stocks and other earning assets. We can see that in the inverse relationship exhibited by price/earnings ratios and the rate of inflation in the past. 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? 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. Indeed, the sharp stock market break of 1987 had few negative consequences for the economy. But we should not underestimate or become complacent about the complexity of the interactions of asset markets and the economy. Thus, evaluating shifts in balance sheets generally, and in asset prices particularly, must be an integral part of the development of monetary policy.
Now, it took more than three years for the Nasdaq to top out from the time Greenspan made the speech.
But the phrase was made famous — or infamous, depending on how you look at it — by Yale professor Robert Shiller, who published the book “Irrational Exuberance” in 2000, predicting the collapse of the dot-com bubble.
Greenspan’s speech has been much-derided as a document outlining how little many critics of the Federal Reserve believe the central bank was aware of the problems that could have been, and were, created by a significant correction in financial markets.
Earlier this year, when Federal Reserve chair Janet Yellen said, “Equity valuations of smaller firms as well as social media and biotechnology firms appear to be stretched, with ratios of prices to forward earnings remaining high relative to historical norms,” many wondered whether Yellen was having her own “irrational exuberance” moment.
That remains to be seen, but here’s the Greenspan clip, courtesy of C-SPAN.
For monetary policy and economic historians, this is essential viewing.
(via WSJ’s Jason Zweig)
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