Not Too Hot, Not Too Cold, Just Right - Understanding the Goldilocks Economy

INTRODUCTION

Borrowing the phrase 'Not Too Hot, Not Too Cold, Just Right' from the classic children's story Goldilocks and the Three Bears, and using the term 'Goldilocks' to describe the economy, Economists are attempting to describe a state of the economy being 'just right' between polar extremes. A 'Goldilocks Economy' exists where there is sufficient system economic growth present so as to be non-recessionary, while at the same time not presenting so much growth to be inflationary. Historically, the 'Goldilocks Economy' is prevalently utilized in describing the indicators present in the economy of Bernanke's 'Great Moderation' [Bernanke, B. The Great Moderation. (Accessed September 19, 2021)].

**CHARACTERISTICS OF A 'GOLDILOCKS ECONOMY'*

Despite some apparent disagreement among Economists, from a general standpoint, the following are the main characteristics associated with a 'Goldilocks Economy':

A rate of low inflation present in the economic system as measured quantitatively using such metrics as the Consumer-Price Index and the Producer-Price Index. This measure is indicative of the country's purchasing power of it's money.
A rate of low unemployment in the economic system as measured by the Department of Labor U3 metric (number of people willing and able to work who are unable to locate gainful employment, plus that have sought such employment within the preceding four weeks). According to the Federal Reserve, optimally this rate will fall between 5% and 6.7% [Federal Reserve Bank of San Francisco. What is the New Normal Unemployment Rate. (Accessed September 19, 2021).
Asset price inflation is present in the economic system. Stocks and bonds, real estate and other investment style assets will increase in price.
Low interest rates (the cost percentage on the amount of money a lender is willing to lend to a borrower) are present in the economic system which are determined by the overnight rate as set by the Federal Reserve [Federal Reserve Bank of San Francisco. Setting the Interest Rate. (Accessed September 19, 2021).
And the most important agreed upon characteristic, a steady economic growth in GDP (Gross Domestic Product) is present in the economic system (ideally between 2% to 3%). GDP measures the value of services and finished goods produced in the economy and as such is a metric indicative of the general health of the economy in question.

Why is the metric of GDP growth so important in determining (and maintaining) a Goldilocks Economy? This answer is readily apparent. When GDP growth is too low, the economy may enter a period of severe downturns or a recession. If GDP growth is too high, prices of goods in the economy may surge and inflation present itself.

**GOLDILOCKS AND THE UNITED STATES ECONOMY - A HISTORICAL REVIEW*

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The Goldilocks Economy is not an illusive phenomenon. In United States economic history for the period 1956 through 2018, there were 12 such periods of identifiable Goldilocks Economies. These are identified as follows:

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 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. This 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%.

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%.

2010: Obamacare was launched, helping the government to cut down healthcare costs. The Dodd-Frank Reform Wall Street Reform Act was enforced to regulate financial markets and to 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.

[Amadeo, K. What Is a Goldilocks Economy?. (Accessed September 20, 2021).

It should be noted that a Goldilocks Economy is transitory. Within capitalist economies, the 'boom and bust' cycle of repeated expansion followed by contraction is a component characteristic.

**THE ROLE OF GOVERNMENT AND THE CENTRAL BANK IN MAINTAINING THE GOLDILOCKS ECONOMY*

**GOVERNMENT*

The Government basically has two tools to utilize to create and/or maintain a Goldilocks Economy.

The US Congress may utilize its spending power to authorize fiscal spending in the area of infrastructure programs (i.e. construction or repair of roads and bridges). Likewise, Congress may approve additional spending through contracts it makes with private entities.
Also, in attempting to manage its economy, Congress may utilize taxes as a tool to create and/or maintain a Goldilocks Economy. By lowering taxes imposed on businesses, Congress in effect is encouraging businesses to invest. In the reduction of taxes on consumers in the system, Congress is in effect encouraging additional consumer spending.

It must be stressed that Congress' use of taxes and/or fiscal spending may yield mixed results due to factors both within and without the economy. As such, utilization of taxes and fiscal spending may only yield short term results in maintaining a Goldilocks Economy.

**THE CENTRAL BANK (THE FEDERAL RESERVE)*

It is the responsibility of the Central Bank (in the US the Federal Reserve) to regulate the supply of money in the economy and more particularly the banking sector within the economy. Accordingly, the Central Bank, by employing its monetary policies, may aid in the creation of a Goldilocks Economy or use the same policy powers to maintain a Goldilocks Economy.

The Central Bank has the power to reduce the rate of interest in the system. This reduction has the effect of increasing lending in the system as businesses and consumers both rush to take advantage of the lower rates. Should the economy be experiencing excessive growth or inflation (in excess of the target rate), the Central Bank may intervene to raise rates of interest to slow the economy.

Inflation (in excess of the target rate) hurts the overall economy effecting both the consumer as well as businesses. Rising prices cause the consumer to spend less in the system. Rising prices cause businesses to cut their investment when the prices in question are their necessary raw materials for production. The added costs of the necessary raw materials eats away at the businesses profit.

When excessive inflation is present, Central Banks intervene to slow growth by raising interest rates. Effectively this action prevents (or at least slows) inflationary pressures. In this regard the Central Banks need to proceed in a cautionary fashion as if they raise rates too soon or too much the action may trigger an undesired economic slowdown or even recession.

It should be noted that the Central Bank also has the authority to control the supply of money in the economic system. Through bond sales and purchases, the amount of money present in the system may be manipulated to deal with inflationary/deflationary systemic ills. By pumping cash into the system the Central Bank in effect is encouraging expansion. Conversely, by removing cash from the system it is creating system contraction.

**INVESTMENTS AND THE GOLDILOCKS ECONOMY*

The capitalist US economy routinely passes through five different phases in its 'business cycle'.

Growth (expansion)
Peak
Recession (contraction)
Trough
Recovery

As alluded to above, it is this tendency of the economy to follow this 'business cycle' that results in the Goldilocks Economy being transitory. However, it is during either the growth or recovery phase that the Goldilocks Economy is possible if conditions are right.

The optimum time for investing is when the economy exhibits Goldilocks characteristics. In the time frame of a Goldilocks Economy, businesses exhibit growth and thereby increased earnings which cause stock prices to rise. Investors are rewarded with appreciated stock prices and possibly dividends as the businesses return portions of the increased earnings back to their shareholders. Likewise, fixed-income instruments retain their value as inflation is at its optimal level. As for cryptocurrencies, it can be assumed that coin/token prices would increase, but due to the novelty of crypto no historical support is present to support this.

In the event that GDP growth during the Goldilocks Economy is too quick, or, if inflationary pressures grow too fast beyond target, asset prices will most likely become overvalued. It is at this point the Central Bank will likely intervene to cool the economy by raising interest rates. When this occurs however, one of the key characteristics is negated (low interest rates) which tolls the death knell for the existing Goldilocks Economy.

**CONCLUSION*

The Goldilocks Economy is not an illusion and as demonstrated has presented itself in the economy of the United States in the recent past. It is, however, your author's opinion that given the current Administration's approach to the economy in the US, coupled with the inaction of the Federal Reserve, the possibility of another Goldilocks Economy in the near to mid term future is highly unlikely.

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