South-Western College Publishing - Economics  
The Goldilocks Economy
Topic Employment, Unemployment, and Inflation
Key Words Inflation and Recession
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Reference ID: A156376303

News Story Consider an ideal world where the economy is running so smoothly that there is no anticipation of overheating and pushing prices higher. In this scenario there would also be no guessing about what the Fed would do with interest rates. In this ideal world the job market would be strong, growth stable and no fear on a coming recession. Economists have coined a phrase to identify this scenario - a "Goldilocks economy."

The current economy however does not reflect this ideal world, but a situation where some of the porridge it to hot and some of the porridge is too cold. With both hot and cold measures to consider, economist offer wide and differing views on the economic outlook for next year.

Both the housing market and the auto industry have fallen into a deep freeze but commercial construction and high-end consumer spending appear to be sizzling. These conditions are making it challenging for economic analysts in general and the Federal Reserve in particular to decide which risk is greater: that the housing market will produce a drag on the economy, inducing the Fed to cut interest rates, or that inflation will remain above the Fed's 2 percent comfort level, causing the Fed to increase interest rates.

Some economists point to the down turn in home construction as a reason to pare back their forecasts for economic growth in 2007. In fact, some have started to utter the R-word. "we've increased the probability of a recession in our forecast to 35 percent," said David W. Berson, chief economist of Fannie Mae.

On the other side of the picture, countervailing forces such as high employment, wage and income growth, and a robust business investment bode well for the economy. "None of this speaks of a slowdown," said Charles Dumas, an economist with Lombard Street Research, a British economic forecasting firm. "There has to be a landing but I don't wee any signs of it yet."

The final outcome may depend on the consumer. Because of the fall in housing prices, consumers are making fewer mortgage equity withdrawals. Consumer spending is still strong, fueled by new jobs and wage growth. However, if the consumer stops spending, businesses will stop investing.

The "just right" economy is seldom achieved anyway, but this condition of being both too hot and too cold makes it very tricky to forecast the future. The unpredictability of the current situation is partly related to the fact that nobody has ever witnessed how a scenario like this unwinds.

Discussion Questions:
1. Discuss the conditions under which you might expect the Fed to cut interest rates.
2. Describe and economy that is both too hot and too cold at the same time.
Multiple Choice/True False Questions:
1. The downturn in housing means the economy is too cold.
  1. True
  2. False
2. If consumers begin to spend less, business will have more to invest.
  1. True
  2. False
Source Eduardo Porter, "An Economy of Extremes" The New York Times Online, December 26, 2006.
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