Their judgement on interest rates will depend on how much faster than the sustainable rate of growth they reckon the economy is expanding. A simple principle, but difficult in practice because nobody knows what the economy's potential growth is. This hasnot stopped Mr Clarke and, yesterday, Anthony Nelson, Economic Secretary to the Treasury, from suggesting Britain is now able to sustain faster non-inflationary growth than in the past. The allure of this notion is that it implies not much more tightening of the interest rate screw is needed to keep anti-inflation policy intact. If there is higher growth potential than the Treasury's cautious 2-2.5 per cent estimate, the economy does not need to be slowed down much further.
The reason ministers give for believing Britain's economic potential has improved is greater flexibility in the labour market. Weaker unions, contracting out, part-time and short-term work and similar developments have made it possible for firms to expand productivity and output without raising wages or prices as in the past.
As one Treasury official remarked yesterday, ``I seem to have heard that somewhere before.'' The argument is an eerie echo of the supply-side miracle Mrs Thatcher's ministers boasted about in the 1980s. Then, as now, the government chose exactly the mosttempting point of the business cycle, when growth was still fast and inflation relatively low, to make its claim for improved potential.
It might be true. The most interesting propositions in economics are often impossible to prove definitively until it is too late. On the other hand, it might simply be the case that labour market flexibility has made the economy more volatile, that jobs and output will fall as fast in recessions as they have climbed in the recovery.
Mr Clarke has to make a solid case if he wants to base policy on his claim that the economy's growth potential has improved in the 1990s. The financial markets, at least, will not forgive any misjudgement on this.Reuse content