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An overheated Economy is a condition where the economy runs too fast so that it exceeds its capacity. Overheating economic conditions are characterized by an economy that continues to grow, but inflation is high.
Economic growth is indeed a positive thing for a country's economy. But when it happens excessively, like an engine that is driven to work constantly, there will be overheating, the engine overheating and it can end in an explosion. The same thing can happen to a country's economic system which means a crisis.
Now imagine a country whose economy begins to grow. The production runs smoothly and produces many products that are consumed by the people. Then, people can also afford to buy the goods produced.
This causes the economy to improve, as manufacturers profit from the sale of products. Meanwhile, on the community side, there is an increase in income and purchasing power, because producers who carry out production must maintain the pace of production and even increase it by increasing the number of workers.
The cycle continues, production capacity is getting bigger, and people's income is increasing. But the cost of production eventually increased greatly, causing an increase in the price of goods sold. Thus, at this point, inflation begins to occur. The growth of production capacity and the increase in purchasing power that occurred simultaneously caused a collapse in the inflation rate.
If this continues to happen, it will be up to a point where price increases can no longer be pursued by people's purchasing power, and that's when there is an "explosion" that causes the economy to decline, even in the worst-case scenario it can cause a crisis.
An overheated economy can also create bubbles in the economy. For example, there is an asset or item that has increased rapidly in price unreasonably. And when there is a crisis, the bubble will burst and the asset will lose its value.
Rising property prices usually also occur at times when the economy is overheating, for example as happened in the United States before the global crisis of 2007.
Therefore, in macroeconomics, the government as regulators and economic policymakers must keep the economy running "not too hot". Do not let there be an excessive increase in inflation even though the economy is growing at the same time.
Don't be tempted to look at economic growth figures but forget about the stability of inflation. Even because of the high economic growth, it will be meaningless if the economy explodes because it is too hot.
Causes of an Overheated Economy
The cause of an overheated economy is the natural behavior of humans in the economy. When there is an increase in income, humans tend to spend more money and buy more goods and services.
It is this high level of consumption that makes manufacturers constantly strive to increase production capacity without considering the adequate allocation of resources.
But if we look at it from the regulatory and government side, there is one factor that can contribute to the occurrence of the situation above, namely the benchmark interest rate that is too low. Yes, however, massive increases in production capacity and consumption activities can occur, one of which is driven by low-interest rates.
Logically, the credit disbursed will be more because the interest is low, and the consumption credit taken by the people will also increase. In essence, overheating also occurs because there is too much money circulating in society.
How to Overcome an Overheated Economy
Because one of the causal factors that encourage the occurrence of an overheated economy is the amount of money that is too much circulating in the community, one of the main solutions to overcome the overheated economy is to reduce the amount of money supply.
The most popular way is of course to increase the benchmark interest rate. Yes, according to macroeconomic theory, when inflation is too high, the logical step that can be done is to increase interest rates.
The pace of credit will loosen, and the burden of operating costs will increase so that producers will tend to restrain the pace and increase production capacity. Consumers will also refrain from taking consumptive credit because of higher interest rates.
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