Happy 19th birthday, 'irrational exuberance'! Greenspan's famous words

US President Bill Clinton (R) walks with Federal Reserve Board Chairman Alan Greenspan at the White House in Washington February 22, 1996.
Jim Colburn | AFP | Getty Images
US President Bill Clinton (R) walks with Federal Reserve Board Chairman Alan Greenspan at the White House in Washington February 22, 1996.

It was Dec. 5, 1996. Bill Clinton had been re-elected the previous month by defeating Kansas Republican Bob Dole in an electoral college landslide.

Alan Greenspan, then chairman of the Federal Reserve, used the phrase "irrational exuberance" in a speech he gave discussing the challenges of central banking. Greenspan was speaking at a dinner hosted by the American Enterprise Institute.

Specifically, the transcript on the Fed's website quotes him as saying:

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.

Looking back, the most interesting thing about the speech was the market's relatively placid reaction. In the immediate aftermath, Asian markets fell 3 percent and domestic equities took a hit as well in a knee-jerk selloff. Yet within a few days, those losses had all but disappeared.

Within a few weeks, the S&P 500 Index was up over 10 percent from when Greenspan made his remarks. In fact, it took the Nasdaq composite more than three years to burst, spelling the end of the technology bubble.

Here's what the S&P 500 looked like during Greenspan's time at the Fed, with the six months after his "irrational exuberance" comment highlighted:

The phrase has taken on a life of its own — it even has its own Wikipedia entry. But what's most surprising is how the markets basically just ignored his comments and kept pressing ahead. Eventually it all shook out, but that took years.

The question is: What phrases and words, comments and speeches will one day stand out as a harbinger to come? As we wrap up 2015 and head to 2016, are there telltale signs of the future that will seem "obvious" after the fact?