Overheating
Topic: Economic Growth Theories and Business Cycles · NCERT: Beyond NCERT
Meaning
Overheating happens when demand grows faster than the economy's productive capacity. The economy is pushed beyond potential output, which is the highest output it can keep up without speeding up inflation. The result is a positive output gap, where actual GDP is above potential GDP. Four signs show it:
- rising inflation;
- a widening current-account deficit (CAD), which means importing more than exporting;
- asset bubbles in shares or property;
- a positive output gap.
Example
In Keynesian terms (Class 12), overheating is a state of excess demand. Equilibrium output is above full-employment output, so prices rise. Central banks usually respond by raising rates. For example, the RBI raised the repo rate from 4.0% to 6.5% between May 2022 and February 2023.
Don't confuse with
- Boom in expansion: strong growth is not always overheating. It becomes overheating only when demand runs ahead of capacity.
Related concepts
- Business cycle
- Expansion
- Goldilocks economy
- Peak
- Trough
- Recovery
- Soft landing
- Economic slowdown
- Growth recession
- Recession