Overheating (economics)

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Overheating of an economy occurs when its productive capacity is unable to keep pace with growing aggregate demand. It is generally characterised by an above-trend rate of economic growth, where growth is occurring at an unsustainable rate. Boom periods are often characterised by overheating in the economy.

1 Causes
2 Effects
3 Historical instances of overheating
- 3.1 Recently
- 3.2 Historically
4 External links

[edit] Causes

High levels of aggregate demand tend to be the cause of overheating. If aggregate demand exceeds aggregate supply, then the excess demand for goods must be met via the over-employment of resources. This may be achieved by employing workers for extra shifts or using machinery beyond their recommended working hours. This type of production is considered unsustainable because the over-employment cannot be supported indefinitely.

[edit] Effects

Overheating is generally preceded by lower than average economic growth. Demand pull inflation occurs as suppliers try to capitalize on the excess demand which cannot be met via existing production constraints. These higher prices tend to reduce aggregate demand and exports (since goods and services become relatively more expensive abroad) leading to reduced consumption. Central banks often simultaneously tighten monetary policy in response to increased inflationary pressures, reducing investment expenditure, which in tandem with decreased consumption, can lead to economic recession.