Semi-Daily Journal Archive

The Blogspot archive of the weblog of J. Bradford DeLong, Professor of Economics and Chair of the PEIS major at U.C. Berkeley, a Research Associate of the National Bureau of Economic Research, and former Deputy Assistant Secretary of the U.S. Treasury.

Wednesday, December 13, 2006

Greenspan's "Irrational Exuberance" Speech and Asset Price Targeting

Mark Thoma sends us to John Berry's puzzlement over the strength of the reaction to Alan Greenspan's "irrational exuberance" speech:

Economist's View: Greenspan's Irrational Exuberance and Asset Price Targeting: John Berry looks at a topic addressed here a few days ago, an evaluation of Fed policy in light of Alan Greenspan's use of the phrase ''irrational exuberance,'' i.e. whether the Fed should target asset price bubbles....

'Irrational Exuberance' Baffles 10 Years Later, by John M. Berry, Bloomberg: Ten years ago this week, Alan Greenspan... slipped the phrase ''irrational exuberance'' into an otherwise unremarkable long speech.... His use of the phrase triggered a debate about the role of asset prices in monetary policy decisions that has never ended. In December 1996, the asset prices in question were those of equities. Many of Greenspan's critics later complained that after having raised the issue of a possible stock price bubble, he and his Fed colleagues didn't do enough to deflate it before its bursting led to the 2001 recession.

The same complaints about Greenspan... and his refusal to deal with asset price bubbles also are being heard now regarding housing prices.... However, even as he described how ''irrational exuberance'' could cause asset prices to climb rapidly, and perhaps add to inflationary pressures, Greenspan never suggested central banks should try to prevent a bubble from developing. Rather, if one did, he said, a central bank should only stand ready to limit the damage that might be done to the broader economy if the bubble burst.

In the December 1996 speech... the Fed chairman's use of the ''irrational exuberance'' phrase was so subtle that it was far from clear that he even had the U.S. stock market in mind.... [T]he Japanese press overnight jumped on the story, drawing the conclusion that the Fed chairman was hinting at rate increases to curb rising stock prices.... In congressional testimony the following February, Greenspan expanded on his ''irrational exuberance'' comments. Analysts' projections of profit growth needed to justify the high level of stock prices would be validated only if productivity growth accelerated and increases in compensation did not, he said. ''Neither, of course, can be ruled out,'' Greenspan said in a context that made it clear he didn't really expect that to happen. Of course, it did.

Princeton University economics professor Burton G. Malkiel, author of the widely read book, ''A Random Walk Down Wall Street,'' said during a seminar at the university in April 2005, that when Greenspan caused a stir by mentioning ''irrational exuberance'' there was no bubble in stock prices. And he and others at the seminar, including several present and former Fed officials, all agreed that the central bank should not try to target the prices of equities, homes or other assets...

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