Goldilocks and the Three Bears is not only a fairy tale but also a term used to describe the state of the global economy today. A Goldilocks economy is an economy that is somewhere between the tides—not too high and not too low—and that is what makes it sustainable.
How can the economy remain in this Goldilocks position?
- Growth—first, the economy needs to grow but at a moderate pace so as not to become overheated, which can affect the second point—relatively low inflation.
- Inflation—low inflation is mandatory; otherwise, the central banks would have to increase interest rates, thus increasing the cost of borrowing and receiving credit for consumption and other purposes, essentially making the cost of money higher. This will hurt the growth of the economy, as economies love cheap money.
- Unemployment—a decrease in unemployment as we see today can cause inflammatory pressure, as there is more competition for each employee, and salaries tend to move higher in that case.
Currently, we are in a rare 3 from 3 status. The global economy is growing at a fast pace. Growth in 2017 is estimated to be around 3.6% and expected to reach 4% next year. Interest rates are increasing at a very moderate pace and not really slowing growth. Inflation is within the range that central banks can handle, and pressure for salary raises is still held in check.
This is a rare state from a historical perspective but also a rare scenario based on economic theory, which, as well as empirical evidence, shows a negative correlation between unemployment and inflation. This phenomenon was first described by the economist William Phillips and is known after him as the Phillips Curve. This curve describes the inverse relationship between unemployment and inflation, as lower unemployment leads to competition over employees and salaries increase, while higher unemployment means that there is an oversupply of employees, which triggers decreasing salaries, thus lowering inflation.
Is the Goldilocks economy sustainable?
How long can the economy stay hot but not overheated? According to central banks, not too long. Last year was a good year—much better than economists expected, and the results are easily shown in stock market prices—but the U.S. seems to be getting close to a full employment scenario, which will trigger inflation. Europe is still a bit behind, but recovery seems to indicate that it’s here to stay, and even Japan is beginning to grow faster. Rumors of China’s demise were greatly exaggerated, as the country is still showing significant growth. To that we can add India and other developing countries enjoying higher consumption, which fuels their growth.
The Goldilocks economy is probably only a phase in the economic cycle that cannot be sustained for very long. Inflation will likely soon begin to increase, interest rates will follow, and the cycle will come to an end. It does not have to be a catastrophic end such as the one in 2008, but we cannot ignore such a possibility. It’s just a matter of time because the economy does not function as a thermostat.
When will the party be over?
A sign for the future can be seen in the financial economy, which is usually followed by the real economy (the subprime crisis started as a financial crisis, which then transformed into a global economic crisis). Essentially, all assets are expensive today. We keep hearing about the run of the stock market, but real estate and fixed-income markets have had great runs as well. They were the first ones to forecast the Goldilocks Economy, and they will also be the first ones to forecast its end.