Sean O'Grady: Crisp new fivers are on the way – but that's the least of our problems

Economic Life: Things must be getting back to normal if the Governor of the Bank of England has returned to where he was rudely interrupted in 2007
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I have been waiting for this moment for some time. The Bank of England is sorting out the fiver. If you'll pardon the journalese, a crisp new fiver is on its way to you to replace that grubby bit of paper in your change. The Bank has been incentivising the banks and supermarkets to stock more new ones. About time.

But the reason I was really heartened by the development was that it signalled a certain return to normality at the Bank of England, and thus the economy.

You see, way back in the balmy summer of 2007 the weightiest thing on the mind of the Governor of the Bank of England was the condition of our £5 notes.

In his Mansion House speech of 20 June 2007, Mervyn King fretted aloud about "soiled and scruffy" promises to pay the bearer on demand. Then Northern Rock collapsed, all hell broke loose and the rest is financial history.

So imagine my joy at receiving a press release from the Bank of England this week, proudly announcing that there will be a fivefold increase in the number of £5 notes in circulation, complete with Mr King's comment that the fiver should start looking "smart". Things must be getting back to normal if the Governor has returned to where he was rudely interrupted in 2007.

So now that the dignity of the £5 note has been restored, are things really back to normal? Maybe not. One of Mr King's deputies, Charles Bean, gave us a few clues this week about what's on the Bank's mind. One thing they're evidently not bothered about too much was their utter failure to predict the severity of the recession that eventually hit us. As the chart shows, the Bank was pretty upbeat about things even in the autumn of 2008, and the chances of what was to soon overwhelm us was taken to be "virtually negligible".

It's characteristically decent of Mr Bean to be so open about that failure, even if he insists that everyone else was in the same boat. The point is that finding out what is happening in an economy below the surface is very difficult. It underlines their current caution about the capacity of the UK economy, or rather the extent to which it is currently operating below its capacity.

Well, things are obviously not going at full pelt just now, but the extent of the margin is impossible to measure, prone to change unpredictably over time, and, unfortunately, crucial to everything. The worry, highlighted by Mr Bean, is that the machinery, equipment and workers that have so far been mothballed in the recession, and thus ready to emerge when demand recovers, may increasingly be scrapped, and thus unavailable, no matter how much stimulus is administered. In human terms, it means that the over-50s and the very young – the usual victims when things go bad – face a long period indeed on the dole.

Overall, this suggests a step-change downwards in growth, and lower living standards (including public services) than we would otherwise have enjoyed. In the often-used analogy with driving a car, it is as if the UK's smooth six-cylinder engine has been replaced by a smaller four; top speed and acceleration inevitably suffer, no matter how heavy your foot lands on the accelerator pedal.

That would imply that the Bank has less scope than it would have had to boost the economy through printing more money and keeping interest rates low, as an economy with less capacity is more prone to inflation. That, therefore, means less chance of interest rates staying ultra-low for as long as some of us might like. The recent bullish growth figures might also reinforce that school of thought. No one's tracker rate mortgage is about to soar, but it might edge up a little more quickly next year than expected, if this turns out to be the case.

So what is going on? Nowhere is the puzzle more difficult than in the labour market, and nowhere is the changing nature of the economy being more intriguingly revealed.

The recent surprise, now well observed, was that unemployment did not spiral as high this time as in previous recessions. Take the early 1990s slowdown. Then, employment fell more than output; but in the "Great Contraction" of 2008-09, output fell by much more than employment. The reason was that wages have become less "sticky" and more flexible downwards than before. Some factors in this are apparent; union power is not what what it was, especially in the private sector, where most of the adjustments came. Attitudes have radically altered. The nature of this slump, accompanied by naked financial panics and rolling media coverage of the failure of bank after bank and, latterly, sovereign state after sovereign state, was qualitatively different to anything in human history, and thus altered psychology in unforeseeable ways. We were scared.

Hence the wave of voluntary pay freezes in 2008 and after; much less remarked upon is the way real wages were decimated for those unlucky enough to leave a conventional, relatively secure, full-time "proper" job with a final salary pension scheme. Some now find themselves working casually with not even paid holidays, their income a fraction of its old level.

The awkward truth is that the new British economy that is being forged in the white heat of austerity is geared to low-quality jobs. That will keep the benefit bill low and keep some people in touch with the world of work. Good. But it also betokens a weak, impoverished sort of economy.

The rebalancing of the British economy is not, on the whole, pushing ex-public sector and traditional manufacturing workers into new hi-tech service companies or technologically advanced industry, but into hairdressing, bar work and other "McJobs". There is more self-employment too, though some is bogus, as in the euphemism "freelance" for "unemployed". People don't like this way of life – around 1.5 million, according to the Office for National Statistics, say they have accepted part-time work or are temping because they cannot find a real job – but that, for now, is all there is. Some have given up on finding work at all, human scrappage. As the months drag on, and their motivation and skills atrophy, cyclical unemployment may be turning structural.

As in the 1970s, the appearance of vast unused resources – especially mass unemployment – may give a misleading impression of huge underused capacity just waiting for a fiscal or monetary stimulus to get the economy productive and moving again. That was a false impression then, and may be becoming so again.

Our car factories were only working at half-capacity and half their workers on the dole in 1975 because no one wanted the cars, not (so much) because of an overall lack of demand. Foreign cars sold well and kept the Germans and Japanese factories busy. Like the Chinese nowadays.

The UK is more competitive than three decades ago, and our cars are wanted, but we may be underestimating the extent to which this generation of unemployed are also in the wrong places and with the wrong skills for anything but the most unskilled of work in those parts of the economy most insulated from foreign competition, shelf-stacking say. Getting an ex-DWP manager in Newcastle a job in a biotech start-up in a Cambridge science park is easier said than done, even if there was a fast bus service between the two. We need to think again about regional policy, and getting jobs to the jobless, and not the other way around.

The demand for labour, after all, is a derived demand, and the demand for British goods and services may not be there because we have relied on the public sector, real estate and financial services for too long, and have yet to find new engines of growth. Even a savage depreciation of sterling has not brought the orders in. The state of our fivers should be the least of our worries.