Magazine article Management Today

The Good News, the Bad News and the Perils of Prediction

Magazine article Management Today

The Good News, the Bad News and the Perils of Prediction

Article excerpt

The belief that growth will flow from low inflation is too simple a belief. David Smith

Is Britain a tortoise or a hare? Two distinct views are emerging on Britain's mediumterm growth prospects. The optimistic assessment takes as its starting point the belief that only economies which have inflation under control can achieve strong and sustainable growth. Britain's current investment in low inflation, painful as it might be, will therefore pay dividends later.

For every optimistic economist there is, at least one pessimist. The gloomy view of the medium-term concerns itself with the nature of the economic adjustment that the British economy was faced with two years ago. Having let the inflation cat out of the bag, the Government had no choice but to clamp down hard on the economy. That policy - we can call it phase one - has been successful.

But the pessimists would say that the real challenge comes with phase two, and a demonstration that low inflation can continue alongside economic growth. A further complication is provided by the fact that Britain has lost competitiveness since entry into the European exchange rate mechanism (ERM) in October 1990. This implies that Britain does not merely need to match average inflation performance in Europe but undercut it.

So which is it to be? Let us begin with the optimistic view. Politicians have a particular dream of economic success. In it Britain acquires the best features of post-war Japan and Germany - rapid growth, a strong currency, a sound industrial base, a healthy trade position and low inflation. Awake, they contrast this paradigm with the realities of post-war British performance, in which these features have made only occasional appearances.

Could it hap.pen? The 'golden age' of the '50s and '60s was one of reasonable growth for Britain, alongside generally low inflation. Over the period 1953-69, economic growth averaged 3% a year, alongside an average inflation rate of 3.3%. It did not feel like an enormous success, mainly because other countries were growing much faster and Britain was losing her share of world trade at a dramatic pace. But it was a record that politic i ans in the '70s (average inflation 12%, average growth 2%) and the '80s (average inflation 7%, average growth also 2%) would have been glad of.

The most ardent advocates of sterling's continued membership of the ERM see Britain as having achieved one half of the golden age package. Inflationary pressures, measured by producer prices, pay settlements, average eamings and credit growth, are at their weakest since the '60s, when sterling was last in a semi-fixed exchange rate regime (we will ignore the embarrassing six-week flirtation with the snake, the ERM'spredecessor, in 1972).

But how does growth follow from this? Low and stable inflation should mean a stable policy environment, with no sudden applications of the brakes of the sort that brought on the recession in 1990. A stable policy environment encourages investment, while low inflation reduces the power of the precautionary motive for saving - if people no longer fear that their savings will be eroded by inflation, they may be prepared to consume more.

The benefits of low inflation partly depend on the growth in world trade, and Britain's inflation performance in relation to competitors. If world trade growth is reasonably strong, if the exchange rate is not overvalued, if the supply side improvements of the '80s have largely survived the recession and if Britain could achieve lower inflation than competitors - four fairly big ifs - then the growth prospects for the '90s would be very promising indeed. …

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