What is a Goldilocks Economy
A Goldilocks economy is an economy that is not so hot that it causes inflation and not so cold that it causes a recession. The term describes an economy that is operating in an optimal state by providing full employment and economic stability. Economists sometimes disagree on the characteristics of a Goldilocks economy, but it is frequently characterized by a low unemployment rate, increasing asset prices (stocks, real estate, etc.), low interest rates, brisk but steady GDP growth and low inflation.
BREAKING DOWN Goldilocks Economy
Regulators use fiscal and monetary policy tools to try to create an economy with these conditions. Economic conditions abroad, and regulators’ reactions to them, also influence whether an economy can achieve a Goldilocks state. This state is ideal for investing, because as companies grow and generate positive earnings growth, stocks perform well. In the absence of inflation, fixed income investments such as bonds will hold their value. If GDP grows too quickly, however, and inflation creeps up too rapidly, the economy can overheat and a bust can result as asset prices become overvalued. Central bankers will react by increasing interest rates to try to stem inflationary pressures. Rising interest rates break one of the key pillars of the Goldilocks Economy and usually are a precursor to its end.
While business cycles vary in intensity and duration, the U.S. economy typically goes through five phases as part of the business cycle: growth/expansion, peak, recession/contraction, trough and recovery. A Goldilocks economy may occur during the recovery and/or growth phases. The U.S. economy of the mid- to late-1990s was considered a Goldilocks economy because it was "not too hot, not too cold, but just right." This term has also been used to describe the U.S. economy as it recovered from the tech bubble burst in 2003–2004 and as it expanded in 2013 after the housing bubble burst in 2008. Because of the existence of business cycles, a Goldilocks economy should be considered a temporary state.
Limitations of the Goldilocks Economy
It is rather difficult for central bankers to engineer a Goldilocks Economy. There are many factors that need to come together for this economic state to exist. Specifically, central bankers need to conduct a monetary policy that prevents inflation and promotes economic growth. If bankers raise interest rates too soon, it can trigger an economic slowdown. Raising interest rates too late can allow inflation to get out of control. Fiscal spending by Congress is another way to help manage this cycle, but the effect can have mixed results and is rarely a long-term solution to maintaining the Goldilocks economy.