Jeremy Siegel: Irrational Exuberance, Reconsidered
[Mr. Siegel is professor of finance at the University of Pennsylvania's Wharton School.]
Ten years ago yesterday, Alan Greenspan made what was to become the most famous speech in his 18-year tenure as chairman of the Federal Reserve. Against a backdrop of a strong economy and soaring stock market, Mr. Greenspan said: "How do we know when irrational exuberance has unduly escalated asset values? . . . We should not underestimate . . . the interactions of asset markets and the economy. Asset prices, particularly, must be an integral part of the development of monetary policy."
Stocks indeed were surging when Mr. Greenspan spoke at the annual dinner of the American Enterprise Institute in Washington. The Dow Jones Industrial Average had crossed 5000 in November 1995 and 6000 in October 1996. On the day of Mr. Greenspan's speech, the Dow industrials stood at 6437, more than twice the level it reached only four years earlier. Many economists claimed that the market was already too high, and some maintained that if the central bank didn't step in and cool the market, a subsequent crash could cripple the economy.
The Fed chairman's speech seemed to agree with those fearful of the soaring market. His words sent shock waves through the world's financial markets. Stock prices slumped world-wide and the Dow industrials fell over 100 points when the market opened the next morning. But in the ensuing months, stocks continued to rise and the Fed did little to stop the bull market. Mr. Greenspan seemed to back away from his earlier statements, noting that the surprisingly strong growth in productivity and corporate profits may indeed justify higher stock prices.
After the market broke downward in 2001 and 2002, economists criticized Mr. Greenspan's inaction during the bull market, arguing that if he had stuck to his guns, the U.S. would have avoided the bubble in both the stock market and its economic fallout. The Economist magazine was particularly vocal in its criticism, asserting in a 2002 lead editorial, "If the Fed had popped America's bubble sooner, its economy would be healthier . . . Ironically, Mr. Greenspan was among the first to give warning of a bubble in 1996, drawing attention to the market's 'irrational exuberance.' What a pity he failed to put America's monetary policy where his mouth (briefly) was."
The debate, then, was engaged. Should Mr. Greenspan have acted against the rising stock market when he made his famous "irrational exuberance" speech?
Now that we have 10 years of economic and financial data, we can now accurately determine whether the market was indeed "irrationally exuberant" in December 1996. The answer is decidedly no. Had the market been overvalued, it would have shown poor return in the following decade. But it did not....
History has exonerated Alan Greenspan's policy during the late 1990s. There is no good evidence that the market was in a bubble when he uttered his famous line 10 years ago, and he was wise in stepping back from it. Irrational exuberance finally did hit the stock market, but not at the time or in the scope envisioned by his critics.
Read entire article at WSJ
Ten years ago yesterday, Alan Greenspan made what was to become the most famous speech in his 18-year tenure as chairman of the Federal Reserve. Against a backdrop of a strong economy and soaring stock market, Mr. Greenspan said: "How do we know when irrational exuberance has unduly escalated asset values? . . . We should not underestimate . . . the interactions of asset markets and the economy. Asset prices, particularly, must be an integral part of the development of monetary policy."
Stocks indeed were surging when Mr. Greenspan spoke at the annual dinner of the American Enterprise Institute in Washington. The Dow Jones Industrial Average had crossed 5000 in November 1995 and 6000 in October 1996. On the day of Mr. Greenspan's speech, the Dow industrials stood at 6437, more than twice the level it reached only four years earlier. Many economists claimed that the market was already too high, and some maintained that if the central bank didn't step in and cool the market, a subsequent crash could cripple the economy.
The Fed chairman's speech seemed to agree with those fearful of the soaring market. His words sent shock waves through the world's financial markets. Stock prices slumped world-wide and the Dow industrials fell over 100 points when the market opened the next morning. But in the ensuing months, stocks continued to rise and the Fed did little to stop the bull market. Mr. Greenspan seemed to back away from his earlier statements, noting that the surprisingly strong growth in productivity and corporate profits may indeed justify higher stock prices.
After the market broke downward in 2001 and 2002, economists criticized Mr. Greenspan's inaction during the bull market, arguing that if he had stuck to his guns, the U.S. would have avoided the bubble in both the stock market and its economic fallout. The Economist magazine was particularly vocal in its criticism, asserting in a 2002 lead editorial, "If the Fed had popped America's bubble sooner, its economy would be healthier . . . Ironically, Mr. Greenspan was among the first to give warning of a bubble in 1996, drawing attention to the market's 'irrational exuberance.' What a pity he failed to put America's monetary policy where his mouth (briefly) was."
The debate, then, was engaged. Should Mr. Greenspan have acted against the rising stock market when he made his famous "irrational exuberance" speech?
Now that we have 10 years of economic and financial data, we can now accurately determine whether the market was indeed "irrationally exuberant" in December 1996. The answer is decidedly no. Had the market been overvalued, it would have shown poor return in the following decade. But it did not....
History has exonerated Alan Greenspan's policy during the late 1990s. There is no good evidence that the market was in a bubble when he uttered his famous line 10 years ago, and he was wise in stepping back from it. Irrational exuberance finally did hit the stock market, but not at the time or in the scope envisioned by his critics.