What is a Goldilocks Economy?
A Goldilocks economy is not too hot or too cold but just right—to steal a line from the popular children's story Goldilocks and the Three Bears. The term describes an ideal state for an economic system where there is full employment, economic stability, and stable growth. The economy is not expanding or contracting by a large margin. A Goldilocks economy is warm enough with steady economic growth to prevent a recession. However, growth is not so hot as to push it into an inflationary status.
Goldilocks Economy Explained
Although there is some debate among economists as to the exact characteristics of a Goldilocks economy, it's safe to say there should be a balance between growth, employment, and inflation.
The ideal conditions are typically characterized by:
Low Unemployment Rate
A low unemployment rate—most commonly known as the U3 rate—that defines the number of people willing and able to work but unable to find gainful employment, and who have sought work in the past four weeks. The U.S. Federal Reserve (The Fed) estimates a normal rate to fall somewhere between 4% and 5%.
Increase in Asset Prices
An increase in asset prices—known as asset price inflation—of stocks, derivatives, bonds, real estate, and other assets will earmark a Goldilocks economy. This increase is difficult to see when using broader measures that gauge real economic growth.
Low Interest Rates
Low market interest rates. These rates are the percentage of a dollar amount that a lender will charge a borrower when they lend money. Market interest rates have a basis on the overnight rate—set by the Fed—that is the rate banks charge to lend to one another.
Low Inflation
Low inflation, measured by the quantitative-based—based on a number—consumer price index (CPI) and the producer price index (PPI) also identifies this golden economic state. Inflation describes the purchasing power of a nation's money.
Steady GDP
Steady gross domestic product (GDP) or economic growth is the most cited indicator of the Goldilocks economy. GDP is a broad economic measure of the value of all services and finished goods produced in a country. This measure is a direct indicator of the health of an economy.
If GDP growth is too low, the economy can dip into a recession or an economic downturn.
When an economy has two consecutive quarters—or six months—of negative GDP growth economist say the country is experiencing a recession. If GDP growth is too fast, it can lead to a surge in prices in an economy or inflation.
Bottom Line
A Goldilocks economy describes an ideal state for an economy whereby the economy is not expanding or contracting by too much. A Goldilocks economy has steady economic growth, preventing a recession, but not so much growth that inflation rises by too much. A Goldilocks state is ideal for investing because as companies grow and generate positive earnings growth, stocks perform well.