The Government is promising to bring in a package of measures next week to try to bring down the rate of inflation. Today the Economic and Social Research Institute warns that reacting to inflationary concerns by taking actions that further fuel growth would not be advisable. The Institute believes that reducing indirect taxes would be a mistake; it would cut the measured rate of inflation in the short term, but by reducing prices in the shops would fuel consumer spending.
The ESRI goes on to say that income taxes should not be cut in the forthcoming Budget, as this would further add to demand. And it also makes a broader point about the discussions between the Government and the trade unions. By manipulating the measured rate of inflation to bring it into line or below Programme for Prosperity and Fairness increases, the Government could be encouraging a cycle in which prices and wages chase each other upwards, it warns.
Much then for the Government to chew on as it finalises its response to union demand that it "do something" about inflation. At this stage, the signals are that it will introduce extensive "price monitoring" and try to encourage more competition in areas such as the grocery trade and the pub business. Reductions in indirect tax look unlikely immediately, but may be held in reserve as an option for the December Budget. And that Budget is also likely to bring further reductions in income tax - against the advice of the ESRI - and new measures to encourage employee share ownership and profit sharing.
How should the ESRI advice influence Government policy? Certainly there is a strong case to act on pro-competition measures, including issuing more licences for public houses and encouraging both the Director of Consumer Affairs and the Competition Authority to pursue their briefs vigorously. The Government also appears to be considering the repeal of the Groceries Order, which bans below cost selling for basic food items. This would have the welcome effect of spurring competition - in the short term at least - although there is a danger that it could damage smaller outlets.
Attempting to actually control prices in areas such as drink has also been considered, but is a difficult policy to implement, as past experience has demonstrated. It remains to be seen what value can be obtained from the promised increase in "price monitoring."
Early reductions in indirect taxes do not appear to be on the agenda. However despite the ESRI's warning that lower indirect taxes might fuel demand, this option is worth keeping under consideration if it could head off higher wage demands. The Government also appears likely to promise legislation to encourage the wider use of employee share option and profit sharing schemes. Doing so would be a welcome - if overdue - way of trying to control demands for higher basic wage increases by encouraging other reward mechanisms.
Finally, what of the ESRI call to postpone income tax reductions until the economy slows? The problem here is that doing so might only add to wage demands in the short term. However it should be possible to design a Budget tax package which aims most benefits at the lower paid and at measures to tackle labour shortage, while not giving too much away to the better paid in a way which gives an unwelcome impetus to an already fast-growing economy. Unfortunately, it now appears that the 2000 Budget did just that.