High inflation… may constrain the Bank of England’s ability to provide further support to the economy in the event of another adverse shock to aggregate demand. … As a result, it may be wise for the government to have a contingency plan for ‘trimming the sails’, holding back on tax increases and/or delaying spending cuts to ensure that poor growth out-turns in the short run do not sink the longer-term fiscal consolidation plan.
But:
Given this risk to growth and these recent developments, the government could consider loosening its currently planned fiscal tightening for 2011–12. However, this would not necessarily pass through into higher demand in the economy if it merely causes monetary policy to become tighter than would otherwise have been the case. Essentially, the argument in favour of announcing a temporary fiscal loosening in the forthcoming Budget is weaker the more confident one is that it would result in tighter monetary policy.
They have a fair point. Almost anything you do with fiscal policy to support growth is also likely to stoke inflation (which in turn makes higher interest rates likely).
Almost.
Cutting VAT – or undoing last month’s rise – would reduce prices as well as helping growth.
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