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Is the 'Goldilocks' economy coming back?

May 23, 2013

| MoneyRates.com Senior Financial Analyst, CFA

The biggest economic news of the past week was the release of the inflation number for April. The sight of easing consumer prices in the midst of what seems to be a general strengthening of the economy brought to mind an expression that was often used to describe the economy of the late 1990s: the "Goldilocks" economy.

The Goldilocks economy was not too hot or not too cold, but just right. What that really meant was that the U.S. was able to have steady growth without inflation ever getting overheated. Could the current economy be starting to settle into this type of ideal scenario?

Easing inflation

On May 16, the Bureau of Labor Statistics (BLS) reported that the Consumer Price Index (CPI) declined by 0.4 percent in April. While easing inflation is good, normally such a significant drop in prices would bring concerns of deflation as a sign of economic weakness. However, coming amidst generally positive signs of economic growth, this inflation relief is seen simply as removing a potential problem from the economic equation -- at least for the time being.

The challenge for the Federal Reserve has been to apply aggressive economic stimulus without sparking inflation. Recent indications are that this may finally be working, though there should be one caution about inflation. As is often the case, the key to April's CPI number was the energy sector, which saw generally declining prices in April. So far though, oil prices have risen in May. It remains to be seen to what extent that will carry over to inflation as a whole.

The balancing act

Balancing between growth and inflation is the central challenge the Federal Reserve faces, but it's not the only balancing act the Fed needs to pull off.

Whether or not inflation starts to perk up, the Fed must find away to unwind its monetary easing programs without choking off economic growth. This also means having interest rates rise gradually enough that they don't spook the stock market or real estate, both have which have risen largely on the strength of artificially low interest rates. The key to the balancing act will be to have confidence in the economy grow quickly enough to replace the stimulus of low rates.

A Goldilocks scenario for savings accounts

Having economic growth accelerate while inflation remains moderate would be a Goldilocks scenario for many aspects of the economy, including savings accounts. Such an environment would allow the interest rates on savings accounts to rise without inflation negating the value of those higher rates.

The next couple weeks will bring two more key indicators of how well this is playing out. Next week the Bureau of Economic Analysis will release its second estimate of first-quarter Gross Domestic Product, and the following week the BLS will release its employment report for March. Those growth indicators should provide strong clues on whether the Goldilocks scenario is becoming a reality -- or just another fairy tale.

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