A Goldilocks Economy is one in which the Goldilocks Effect has been achieved in the economic arena. This effect is one of balance between two extremes, and takes its name from the storybook character Goldilocks, a little girl who finds herself at the home of three bears. She tests extremes within the realm of food and furniture before arriving at her sweet spot, discovering the item that is ‘just right’ for her.

How was this Term Introduced to Economy?

The term Goldilocks Economy was coined by economist David Shulman in March 1992. He used the expression in a strategy piece for Salomon Brothers entitled, “The Goldilocks Economy: Keeping the Bears at Bay,” referring to an economy that was ‘hot’ enough for profit growth, but ‘cool’ enough to prevent the Fed from raising interest rates.

How does the Goldilocks Effect Appear in the Markets?

While storybook Goldilocks encountered food that was too hot or cold, and beds that were too hard or soft, the stock market often experiences conditions which could be deemed too flat or too volatile. The market also undergoes periods of performance which are too sluggish, resulting in losses for investors, or stages of over-performance leading to the formation of a bubble which must, at some stage, burst.

What Constitutes a Goldilocks Economy?

A Goldilocks Effect on the Economy may be described as one in which there is a low rate of unemployment, a steady increase in asset prices, low interest rates and low inflation. There is also a consistent GDP growth rate, which falls between 2% and 3%. This can be considered as an ideal time to invest. A Goldilocks Market describes the market condition when the pricing of commodities is balanced between a bear market and a bull market.

Notable Mentions of Goldilocks Effect on the Economy

At a White House news conference in 1995, Clinton's Labor Secretary, Robert Reich, used the term ‘Goldilocks Recovery’ to describe the rebound from the recession of the early 1990s.

In February 2007, Former Fed Chairman Ben Bernanke asserted that the US would continue to benefit from another year of the Goldilocks-Economy that it had been experiencing since 2004. However, in its 2007 report, the President's Council of Economic Advisers countered this by claiming that the Goldilocks-Economy was facing its end.

Throwing his hat into the ring in early 2008, Mr. Goldilocks himself, David Shulman argued with both these statements claiming that “The last time there was truly a Goldilocks economy was 2003-2004,” and that the economy hadn’t been “just right” for well over a year prior to that time.

Is Goldilocks in the Eye of the Beholder?

From the varying opinions we just looked at, it can definitely be surmised that, like most things in life, whether or not we are encountering, or will continue to experience, a Goldilocks Effect is open to interpretation.

The three bears themselves would have disagreed on what ‘just right’ really means. One bear’s ‘just right’ is another bear’s ‘too hot.’

This can also be translated to an individual trader’s strategy and approach to the market. How much risk is just right for you? What is your ideal time-frame and capital investment that fits right in between too much and too little? Understanding your own Goldilocks scenario is very important, as whatever the conditions in the markets and the opinions of the people involved, being clear on your personal criteria paves the way for effective trading choices.