Goldilocks Economy: Definition, Causes, Effects

Goldilocks
A goldilocks economy is one that is neither too hot nor too cold. Photo: Paul Hardy - Concept Stills and Motion/Getty Images

Definition: A Goldilocks economy is when growth isn't too hot, causing inflation, nor too cold, creating a recession. It has an ideal growth rate of between 2-3 percent, as measured by GDP growth. It also has moderately rising prices, as measured by the core inflation rate. The Federal Reserve has set this target inflation rate at two 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

This is the goal for both the Fed's monetary policy and Congress' fiscal policy. They seek to create enough demand to keep the economy humming at a healthy pace. 

However, Congress also has political goals that interfere with creating the Goldilocks economy. Congressmen disagree with how to create it. Tea party Republicans advocate supply-side economics and Reaganomics, while others believe in Keynesian policies. 

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 health 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.” (Source: Jeff Sommer, "Fed's Goldilocks Economy Just Right for Investors," The New York Times August 2, 2014.)

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 usually means higher interest rates, which stock traders and businesses dislike because it raises their costs and reduces their profit margins. It included a very clever pun, since the term "bears" describe stock traders who believe the market is declining, or entering a bear market. (Source: Larry Kudlow, "The Truth About Goldilocks," CNBC, January 11, 2008)

Examples

President Bill Clinton's Labor Secretary Robert Reich also described the 1990s as a Goldilocks recovery in a White House news conference in 1995. 

Former Federal Reserve Chairman Ben Bernanke’s reassured markets that the U.S. would continue to benefit from another year of its Goldilocks economy in his testimony to the House Budget Committee on February 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 2000 recession. For more, see 2007 Financial Crisis and Financial Crisis Timeline.

The President's Council of Economic Advisers disagreed in its 2007 report. It called for the end of the Goldilocks economy that the country had enjoyed since 2004. It incorrectly assumed the bank liquidity crisis wouldn't spread beyond banks, mortgages and real estate. It predicted growth would continue through 2008, with an upturn towards the end of the year. It thought that the Bush tax cuts would solve the Subprime Mortgage Crisis. For more, see Economic Report of the President.