An overheating economy shows up when demand grows faster than the economy’s ability to produce goods and services. Businesses operate at full capacity, labor markets tighten, and consumers spend aggressively. This imbalance pushes prices higher because supply simply can’t keep up with demand.

Labor markets provide another clear signal. When unemployment falls to unusually low levels and companies struggle to hire, wages begin rising rapidly. While higher wages sound positive, they can fuel additional inflation if productivity doesn’t grow at the same pace. Employers raise prices to cover rising labor costs, reinforcing the cycle.

Financial indicators also reveal overheating. Credit expands quickly, asset prices climb faster than fundamentals, and investors take on more risk. Central banks often respond with tighter monetary policy, but if they move too late, inflation becomes entrenched and the economy becomes vulnerable to a sharp correction.