It’s a pretty extraordinary prospect.
Britain has been out of recession for more than five years, is the strongest growing economy in the G7 and, if you believe George Osborne, is walking tall again.
Yet Andrew Haldane, the chief economist of the Bank of England, believes the next move in interest rates may be down rather than up, and in the right circumstances can envisage himself voting to cut official borrowing costs from 0.5%.
The reason for this is simple. Despite two years of solid growth and falling unemployment, inflation has fallen. Financial market forecasts for the timing of the first increase in interest rates have been consistently pushed back, while predictions of the eventual peak in rates have been lowered.
There are some on the Bank’s nine-strong monetary policy committee who think it is just a matter of time before inflationary pressure starts to increase. They argue that the collapse in oil prices is the reason why there is downward pressure on the cost of living, and that as more people find jobs earnings growth will pick up.
Haldane floats two other possibilities. The first is that there is more slack in the labour market than the Bank thinks. This might be due to a desire for workers to increase their hours because firms have more capacity or because the number of long-term unemployed is smaller than the MPC thinks. If this is the case, and the disconnect between rising employment and wages in both the UK and the US suggests that it is, the caution over interest-rate increases shown by the Bank and the Federal Reserve is entirely justified.
But there’s more. The relationship between unemployment and wage inflation appears to have changed fundamentally in recent years, so that economies can operate with much lower levels of joblessness without triggering an increase in earnings growth.
With one or two exceptions, it has only been during and immediately after wars that inflation has risen to high levels in developed western economies. For the rest of the time, competition tends to keep prices under control. And labour markets have been operating under intensely competitive conditions. Workers in countries such as the UK have been threatened with their jobs being off-shored, have seen the pool of labour increased by the arrival of skilled immigrant labour, and have seen trade union power reduced.
This process started in the 1980s, when economists used the term hysteresis to describe the permanent scarring left by the recession in industrial Britain on the long-term unemployed. Haldane raises the prospect of a different form of hysteresis following the global financial crisis: a permanent period of weak earnings growth that locks in low wages, low inflation and low interest rates.
This article was written by Larry Elliott, for theguardian.com on Thursday 19th March 2015 19.24 Europe/Londonguardian.co.uk © Guardian News and Media Limited 2010