Goldilocks Economy, Its Causes, and Its Effects
A Goldilocks economy exists when growth is neither too hot, causing inflation, nor too cold, creating a recession. It has an ideal growth rate of 2–3 percent, as measured by gross domestic product growth, and has moderately rising prices, as measured by the core inflation rate. The Federal Reserve has set this target inflation rate at 2 percent.
This healthy economy is named after the famous children's story, "Goldilocks and the Three Bears." The little girl only ate the bear's porridge that was neither too hot nor too cold. Like the porridge, the Goldilocks economy is one that is "just right."
Causes and Effects
The goal for both the Fed's monetary policy and Congress' fiscal policy is to create enough demand to keep the economy humming at a healthy pace. However, Congress also has political goals that interfere with creating a Goldilocks economy. Congressmen disagree with how to create it. Many fiscal conservatives advocate supply-side economics and Reaganomics, which favor lower taxes and fewer regulations. Many liberal politicians believe in Keynesian policies, which advocate for more of a managed market economy, which involves more frequent government intervention.
As a result, the Fed often compensates when political goals interfere with fiscal policy's ability to create the Goldilocks economy. In fact, many analysts now believe it has become sophisticated enough to create a healthy economy no matter what fiscal policy does. As a result, they focus completely on the Fed.
“It’s as though Goldilocks entered the house of the three bears and found the porridge was being heated in a big microwave oven,” said Seth J. Masters, the chief investment officer of Bernstein Global Wealth Management. “Sure, it’s just the right temperature inside, but there’s a reason for it. It’s hard not to focus on the microwave.”
A Goldilocks economy has been rare in U.S. history. Examples of when it has happened and the reasons why include:
- 1956 and 1957: The economy was stable following the end of the Korean War.
- 1960 and 1961: President John F. Kennedy ended a recession by increasing government spending on defense, the new Food Stamp Program, farm supports, and state highway aid funds.
- 1967: The economy expanded during the Vietnam War.
- 1981: President Ronald Reagan’s aggressive tax cuts, increased government spending, and reduction of money supply pulled the economy out of stagflation.
- 1993: The Omnibus Budget Reconciliation Acts of 1990 and 1993 increased taxes and limited government spending. These created a budget surplus and an expanded economy.
- 1995: The Fed raised interest rates which slowed down the previous year’s high growth rate of 4 percent.
- 2003: President George W. Bush’s Jobs and Growth Tax Relief Reconciliation Act helped the economy out of a recession.
- 2006: The Fed raised the rates which slowed down the previous year’s expansion rate to an ideal 2.7 percent.
- 2010: Obamacare was launched which helped the government to cut down health care costs. The Dodd-Frank Reform Wall Street Reform Act was enforced to regulate financial markets and patch up the catastrophic failures of the banking industry in 2008.
- 2012: The U.S. was in an expansion phase, despite almost falling off a fiscal cliff that year.
- 2014–2015: The country was still in an expansion phase, with a strong dollar, low oil prices, and a steady, predictable rise in interest rates.
- 2017–2018: A weakened dollar and President Donald Trump’s tax plan boosted growth.
Origin of the Term
The term may have been created by David Shulman, senior economist of the UCLA Anderson Forecast, who wrote an article in 1992 called "The Goldilocks Economy: Keeping the Bears at Bay."
In it, he described the economy during the Clinton administration, where the economy was hot enough to spur profitable business growth but cool enough to keep the Fed from using contractionary monetary policy to ward off inflation. That means higher interest rates, which stock traders and businesses dislike because of their negative impact on profit margins. The term includes a clever pun since the term "bears" describes stock traders who believe the market is declining or entering a bear market.
Use of the Term
Former Federal Reserve Chairman Ben Bernanke reassured markets that the United States would continue to benefit from another year of its Goldilocks economy in his testimony to the House Budget Committee on Feb. 28, 2007. This was to counter a stock market sell-off triggered by former Federal Reserve Chairman Alan Greenspan’s comment that there was a 50 percent chance of a recession later that year. He was only one year off. Greenspan also mentioned that the U.S. budget deficit was a significant concern. Fed board member William Poole added that stock prices were not overvalued, as they were before the 2001 recession. The financial crisis timeline recounts how the Federal Reserve and the U.S. Treasury dealt with the 2007 financial crisis.
The President's Council of Economic Advisers disagreed in its 2007 Economic Report of the President, warning of the end of the Goldilocks economy that the country had enjoyed since 2004. The report incorrectly assumed the bank liquidity crisis wouldn't spread beyond banks, mortgages, and real estate and predicted growth would continue through 2008, with an upturn toward the end of the year. Advisers thought the Bush tax cuts would solve the subprime mortgage crisis.
In 2017, Horizon Investment's chief global strategist Greg Valliere said the economy had entered a new Goldilocks period, noting that there was solid economic growth without inflation.