Irrational exuberance occurs when prices are bid up from overly enthusiastic and optimistic investors without solid analysis, far beyond their true economic value. (Hayes)
The Feedback Loop Caused By Exuberance
Reflexivity can be caused by irrational exuberance: as investors have skewed perceptions of reality or fundamentals, that too changes reality, and thus prices. This process is self-reinforcing and “tends toward disequilibrium causing prices to become increasingly detached from reality”. (Investopedia) For example, rising home prices incentivised banks to increase their home mortgage lending, and therefore, increased lending which helped drive up home prices further.
Origins
The phrase ‘irrational exuberance’ first gained traction from former Fed chair Alan Greenspan’s 1996 speech, given near the start of the 1990s dot-com bubble (which was an example of irrational exuberance):
"But how do we know when irrational exuberance has unduly (to an unwarranted degree) 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?"
Works Cited
Investopedia. “Reflexivity.” Investopedia, 2019, www.investopedia.com/terms/r/reflexivity.asp.
Hayes, Adam. “What Is Irrational Exuberance?” Investopedia, 8 Apr. 2022, www.investopedia.com/terms/i/irrationalexuberance.asp.
