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A Textbook Example of Overheated Economy!
“An overheating economy is an economy that is expanding at an unsustainable rate.
The two main signs of an overheating economy are rising rates of inflation and an unemployment rate that is below the normal rate for an economy.
Causes of an overheating economy range from external economic shocks to asset bubbles.”(Investopedia)
As you can see the current situation is a textbook example for overheated economy.
What could be the consequences?
When the economy overheats some producers are not able to supply all the goods that consumers demand. This can lead to prices rising faster than they otherwise would. This in turn can cause a "wage-price spiral" to develop, where higher prices lead to higher wages and vice versa.
Overheating can also make households and firms over-optimistic about their future income prospects, and lead them to take on too much debt. If this future income fails to materialise, adjusting to a sustainable growth path can be painful. The result can be bankruptcies, job losses, wage reductions and cuts to public services.
Too much borrowing can be both a source and sign of overheating. This can lead to asset bubbles, notably in housing markets, but also stock markets. Asset bubbles make households feel wealthier and consumption rises above sustainable levels.
The way to cool economic growth is to increase interest rates (monetary policy). This reduces the level of demand in the economy because higher interest rates encourage households and firms to save more, and spend less.
The high rate of "sticky" inflation would suggest that it will be hard for the U.S. Federal Reserve to get price rises under control, even with large interest rate hikes, and it raises the possibility of a prolonged recession.
Learning from past experiences:
The Great Recession during the late 2000s was preceded by an overheating economy. The unemployment rate continuously fell until 2007, culminating at a rate of 4.6% (below the normal rate) in that year. Meanwhile, the inflation rate, which had been steadily rising, peaked at 5.25% in 2006, when Ben Bernanke became the Fed Chair and right before the crisis.
Between June 2004 and June 2006, the Federal Reserve Board (FRB) increased the interest rate 17 times as a gradual means of slowing America's overheated economy. However, two years later, U.S. inflation hit 5.6 percent, a cycle high. This rapid rise in prices was followed by a crippling recession, which saw inflation plunged below zero within six months.
Conclusion:
COVID pandemic and War in Ukraine are external shock but the Monetary policy was main reason for overheating the economy and making wage price spirals and unlike what FED says this inflation is NOT temporary Nor tamed..!
I think it is highly likely we see higher inflation numbers and even bigger interest rate hikes!
Best
The two main signs of an overheating economy are rising rates of inflation and an unemployment rate that is below the normal rate for an economy.
Causes of an overheating economy range from external economic shocks to asset bubbles.”(Investopedia)
As you can see the current situation is a textbook example for overheated economy.
What could be the consequences?
When the economy overheats some producers are not able to supply all the goods that consumers demand. This can lead to prices rising faster than they otherwise would. This in turn can cause a "wage-price spiral" to develop, where higher prices lead to higher wages and vice versa.
Overheating can also make households and firms over-optimistic about their future income prospects, and lead them to take on too much debt. If this future income fails to materialise, adjusting to a sustainable growth path can be painful. The result can be bankruptcies, job losses, wage reductions and cuts to public services.
Too much borrowing can be both a source and sign of overheating. This can lead to asset bubbles, notably in housing markets, but also stock markets. Asset bubbles make households feel wealthier and consumption rises above sustainable levels.
The way to cool economic growth is to increase interest rates (monetary policy). This reduces the level of demand in the economy because higher interest rates encourage households and firms to save more, and spend less.
The high rate of "sticky" inflation would suggest that it will be hard for the U.S. Federal Reserve to get price rises under control, even with large interest rate hikes, and it raises the possibility of a prolonged recession.
Learning from past experiences:
The Great Recession during the late 2000s was preceded by an overheating economy. The unemployment rate continuously fell until 2007, culminating at a rate of 4.6% (below the normal rate) in that year. Meanwhile, the inflation rate, which had been steadily rising, peaked at 5.25% in 2006, when Ben Bernanke became the Fed Chair and right before the crisis.
Between June 2004 and June 2006, the Federal Reserve Board (FRB) increased the interest rate 17 times as a gradual means of slowing America's overheated economy. However, two years later, U.S. inflation hit 5.6 percent, a cycle high. This rapid rise in prices was followed by a crippling recession, which saw inflation plunged below zero within six months.
Conclusion:
COVID pandemic and War in Ukraine are external shock but the Monetary policy was main reason for overheating the economy and making wage price spirals and unlike what FED says this inflation is NOT temporary Nor tamed..!
I think it is highly likely we see higher inflation numbers and even bigger interest rate hikes!
Best
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