A quarter point between friends

So they went up again. The big surprise of the week was the latest quarter per cent increase in interest rates. Well, there's no need here to add to the plethora of comment on the difficulties endured by manufacturing, the current slow-down in the economy generally, the dangers of inflation from higher wages and so on.

The arguments are all well-rehearsed, and how ever often one ploughs through them, it is impossible to escape the fact that the evidence on whether the economy has overheated is ambiguous. No-one can be sure that rates are not significantly too high, or significantly too low. Until it becomes clearer, they will not move far from where they are, give or take a quarter per cent or two. (But then, what's a quarter per cent between friends?)

Rates could be too high

For all this, though, there is one fresh argument about the current state of the economy worth examining. This argument is rather difficult to categorise. It doesn't say the economy is running too fast. Nor does it say the economy is in recession, or that things have slowed down enough already. But it does say rates are too high.

Overdoing it

It reaches this conclusion by arguing that the economy should be allowed to overheat a little. It says the authorities should not overdo their anti-inflationary zeal. Why? Because when the economy hits its capacity constraints, when spending is a little higher than the ability of firms to supply everything demanded of them, when conventional economists are getting worried that inflation will start to creep up - it's only then that suppliers will have the incentive to invest in building more capacity.

In short, if you want a policy to foster long term growth, dynamic firms, lots of investment in the future, you have to run the economy at a level that challenges the economy to keep up.

Skill shortages

Take a practical application of the argument and how it differs from the more conventional view. Every now and then, you'll hear people mutter about skill shortages. Employers will complain they can't get skilled workers. There are surveys that produce tables of how many employers are participating in these mutterings. The Bank of England has tended to view these with some alarm.

Skill shortages mean the price of skilled labour goes up; that means companies will put their prices up; and that means inflation. We need to slow the economy down so that employers can'r sell very much, and thus find they don't need as much skilled labour, and there's no shortage.

Now under the alternative view, this is a very short term view. It's only when there's a skills shortage, with rising wages for skilled people, that anyone has an incentive to create skilled workers. Those muttering employers are the people who should be building the future of the economy up by training people, and a skills shortage is the signal the economy sends them to tell them to do so.

Bottlenecks

So, bottlenecks in the economy create higher prices and inflation. But, it's only by allowing the economy to encounter bottlenecks that bottlenecks will be cleared, and leave the way forward for future growth without those bottlenecks - and the inflation they bring.

Party time