Overheated Economy
Candlefocus EditorAn overheating economy is characterized by an abnormal rate of inflation, driven by rising asset and housing prices, and an unemployment rate that is lower than the natural rate of joblessness for the economy. Inflation is when the rate of increase in prices for goods and services is above the target rate set by the central bank of a country. This happens when there is an imbalance between the demand and supply of goods, or when spending power is higher than what the economy can reasonably support.
When an overheating economy is characterized by asset bubbles such as in real estate, speculative activities like stock market investment dominate and push prices of assets such as housing and stocks beyond reasonable limits. This can be attributed to a number of factors, including monetary stimulus, population expansion and excessive borrowing.
The economy overheats when economic growth accelerates beyond the capacity of economic resources― a situation known as “overheating.” As the economy overheats, prices and wages increase in order to balance out supply and demand, resulting in an unsustainable level of inflation. At the same time, businesses can’t raise prices fast enough to cover their rising costs and are forced to reduce employment, leading to rising unemployment.
The primary risks in an overheated economy include higher inflation, slower economic growth, and higher unemployment rates. To manage an overheating economy, central banks increase interest rates to slow borrowing and cool the economy. In order to stimulate the economy, central banks may also adjust the nation’s money supply, reducing the amount of money in circulation and leading to higher unemployment as businesses and individuals find it more difficult to borrow.
In conclusion, an overheated economy can bring about a long-term decline of an economy’s growth, increasing the the likelihood of a recession. By managing the money supply and interest rates, governments and central banks can protect the economy from overheating and the damaging consequences that can follow.