An overheated economy is an economic condition that is usually caused by loose monetary policy over an extended period of times. The most common type of overheated economy occurs when a nation has kept interest rates extremely low for months or years, leading to a glut of credit and a rapid expansion of the money supply. This expansion spurs GDP growth, but inflationary pressures eventually destroy a currency’s value if the monetary policy stays loose for too long.
There have been many, many examples of overheated economies in the past. The U.S. sub-prime mortgage bubble and the Asian financial crisis are two of the biggest in recent memory. In both cases, easy credit spurred risk taking and growth, but the amount of credit being created eventually became unsustainable, leading to a correction. Many central banks try to prevent an overheated economy through cooling measures like raising interest rates or putting more regulations on lending.
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