Credit Sesame discusses whether the U.S. is heading for an economic Goldilocks zone.
The task of economic policymakers is to steer the economy into an area where it is comfortably between extremes, the so-called economic Goldilocks zone. Recent news reports indicate this may be happening. However, there have also been reminders that the economy is not in the zone yet.
What is the Goldilocks zone?
The term “Goldilocks zone” is used in the context of the economy to describe a situation where economic conditions are “just right,” neither too hot (overheating) nor too cold (in a recession or depression). A state where the economy is growing steadily but not so fast as to fuel high inflation.
The term “Goldilocks zone” was used frequently to describe the economy of the late 1990s. From 1996 through 2000, real GDP growth was never lower than 3.8% and never higher than 4.8%. Inflation was never lower than 1.6% and never higher than 3.4%. The economy was never too hot nor too cold. It was just right.
The Federal Reserve defines its monetary policy goals as striking a balance between continued high employment and low inflation. In other words, many of the Fed’s decisions are around trying to find the Goldilocks zone.
Is the U.S. headed for an economic Goldilocks zone?
Recent economic growth is not as strong as during the 1990s but real GDP has grown in 12 of the past 13 years. The only exception was in 2020, the year the pandemic struck. Does this mean the economy is just right?
Inflation has proved to be too hot. The Fed aims to keep the long-term inflation rate around 2%. But in 2021, the inflation rate surged to 7.2% and remained high at 6.4% in 2022.
The Fed has raised interest rates to cool down demand for over a year. Interest rate hikes are the classic monetary policy tool that takes some of the steam out of inflation.
However, there is a risk that suppressing demand in this may be too successful. Choking off demand too much could result in a recession.
A U.S. economic Goldilocks zone in 2023 is one where inflation steadily declines but the economy continues to grow. Recent developments indicate that the economy might be approaching the Goldilocks zone.
1. Moderate job growth
On Friday, April 7 the Bureau of Labor Statistics announced that the U.S. economy added 236,000 jobs in March.
Inflation is fueled by high labor demand. When unemployment is very low, there aren’t nearly enough workers to fill all the open jobs. That kind of labor shortage creates wage pressure.
The March employment report was a step in the right direction because it showed employment was still growing but slower than in recent months. That suggested the economy is still expanding but at a pace that shouldn’t create as much wage pressure.
2. Job openings ease
A few days before the employment report, the Bureau of Labor Statistics reported that job openings had declined.
At 9.9 million job openings, there are still plenty of opportunities for people seeking work. However, the number of job openings eased over the most recent month and is down from where it was a year ago.
That means some of the excess labor demand is starting to work itself out of the job market. That should mean less wage pressure.
3. Inflation trends down
It was recently announced that the Personal Consumption Expenditure (PCE) Price Index increased by 0.3% in February.
That represents a slowdown from January’s increase of 0.6%. This is also a slower rate of inflation than over the past year.
The PCE Price Index is especially significant because it is the inflation measure that the Federal Reserve prefers over the Consumer Price Index (CPI).
4. Consumer spending growing at a more relaxed pace
The most recent Mastercard SpendingPulse report showed that retail spending increased by 4.7% over the past year.
That represents less spending growth than the recent trend. In fact, a 4.7% increase is lower than the recent inflation rate, suggesting that consumers are buying fewer things.
Lower consumer spending should help take the edge off inflation.
Why things are not “just right” to be an economic Goldilocks zone
While there are signs that the economy is moving towards the Goldilocks zone, there are also reminders that things are not just right, yet.
1. Inflation is lower but still too high
Whether the focus is on the PCE Price Index or the CPI, inflation is slowing but still too high. The PCE Price Index rose 5.0% over the past year, and the CPI 6.0%. Both figures are above the Fed’s target of 2% inflation.
2. Debt suggests economy may be on borrowed time
While the economy is growing, consumer debt continues to set new records.
If the economy is dependent on continued borrowing growth, eventually it has to slow down. Payments on today’s borrowing will subtract from tomorrow’s growth.
3. Banking remains a wild card
The banking system is recovering from a couple of recent high-profile bank failures. The fundamental conditions that led to those failures are may cause issues at other banks.
Bank failures do more than just disrupt the financial system. They directly impact the Fed’s policy.
Fast-rising interest rates helped cause some of the mismatches between assets and liabilities on bank balance sheets. If the Fed senses rate increases are destabilizing the banking system, it may find an important inflation-fighting tool has been blunted.
4. Less oil may mean more inflation
Leading oil producers recently announced an agreement to cut output. Their goal is to drive up oil prices. This is exactly the kind of shock that could result in a fresh boost to inflation.
Are we in the economic Goldilocks zone yet?
The economy may be approaching the Goldilocks zone, but there is no fairy tale ending in sight. Economic pressures and levers over the coming months will govern whether the economy is just right or not.
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Disclaimer: The article and information provided here is for informational purposes only and is not intended as a substitute for professional advice.