In theory, low inflation should mean more jobs. In practice, scope is limited.
Inflation, as everyone knows, is never beaten. Rather, it can be subdued for a while before it regroups and comes back with a vengeance. This has been the pattern of recent years. In the mid-1980s, for example, the collapse in world oil prices led everyone to believe the inflation dragon had been slain. But a couple of years later, and particularly in Britain, it was back, in virulent, fire-breathing form.
I write that by way of a caveat. The difficulty with the 'keep vigilant at all times' argument about inflation is one of degree. Does it mean, for example, that base rates in Britain should never have been reduced from their 15% level of the 1980s - because of the danger that inflation would come back to haunt us. Of course not. Therefore, when finance ministers and central bankers say that to relax policy would risk higher inflation, they are not talking absolutes. Rather, they are saying that they know best. Often as we have seen in recent years, they do not.
The question is a particularly relevant one at present. Oil prices have not collapsed, as they did a few years ago, but they are weak and the Organisation of Petroleum Exporting Countries (OPEC) is struggling with the problem of how to accommodate extra production from Iraq next year without provoking a renewed fall in prices. Other raw materials, similarly, are either falling in price or, at the very least, are no better than stagnant. Industrial raw material prices are down on the levels of a year ago, in large part reflecting the weak world recovery.
At the same time the decelerating growth in world money supply has continued. To any monetarist, this means that inflation will remain low, not just for now but for some time ahead, at a time when growth will remain distinctly unexciting. As the chart shows, the 1990-3 period has been one of weak growth in the industrialised countries of the OECD (the Organisation for Economic Co-operation and Development) whose members comprise OPEC's customers. This has been partly offset by strong growth in the economies of East Asia, excluding recession-hit Japan.
This period of slow growth or recession for the OECD economies has produced a significant output gap, the difference between actual and potential (or trend) output, as is evidenced in high levels of unemployment and spare capacity throughout the world. Even with a robust recovery, therefore, it would take two or three years before this gap was made up. The weak recovery that is in prospect means that the gap will persist for longer than that, keeping down inflation.
In Britain, the Treasury's fear is that the labour market leopard has not really changed its spots and that even a reasonable recovery will see a significant acceleration in annual pay increases. Even if it were true, there is no reason why higher pay settlements should add to inflation. For one thing, most companies, particularly bigger ones, are still retrenching on employment. For another, higher pay settlements that are offset by productivity gains are only a problem if they encourage groups of workers who are not achieving such gains to follow suit.
The implications of a low-inflation world recovery are many. But one is that there will be a greater policy emphasis on unemployment. Michel Camdessus, the managing director of the International Monetary Fund, recently called on the industrial countries to refocus their efforts on the task of reducing unemployment. Coming from an organisation that was in the vanguard of the anti-inflation policy orthodoxy of the 1980s, this was significant indeed.
Stephen Dorrell, financial secretary to the Treasury, argued recently that job creation will follow naturally from the achievement of low inflation. Low-inflation stability, he said,will encourage a shift in resources away from areas such as housing, attractive in the past as a hedge against inflation, and into 'productive' sectors such as manufacturing. This would be highly beneficial for job creation.
There is clearly something in this. The welcome supply-side reforms of the 1980s, which should have produced a better employment outcome than actually occurred, were scuppered by inept macro-economic management. Assuming this lesson has been learned, the jobs outlook is undoubtedly better.
But where in Britain will the jobs come from? In the 1970s, the great engine of employment was the public sector, and we all know what that led to. In the 1980s, the small business sector, retailing and financial services provided most of the new jobs. These are all areas where the legacy of the recession is most deeply-felt.
Manufacturing employment must increase but, at 20% of the employed labour force, the rise would have to be substantial to make serious inroads into unemployment. Many large manufacturers are still driven by a desire to operate on a tigher workforce.
Policy-makers may be moving towards a refocusing of their attention away from inflation and towards solving the problem of persistently high unemployment. But the difference between words and the scope for effective action is probably greater in this area than anywhere else.
David Smith is economics editor of the Sunday Times.