so would simply spread inflation and harm the recovery. the extent of indexation in the economy is much less than it was decades ago, but there are still some wage and price adjustments that are unavoidably linked to the consumers price index. the 1 october income tax reductions mean most people are already compensated for the effects of the gst increase. given this, there is less argument for one - off cpi - indexed wage increases. a particular message of restraint is for those parts of the economy, both public and private, that have a record of increasing prices by more than the rate of economy - wide inflation. we expect to see relative prices change in a well functioning economy. in a competitive market they represent an important signal for resources to move around the economy in search of more profitable opportunities. a good example is the agricultural transformation that has occurred with the rise in dairy prices. there may also be public policy reasons why some prices move more than others. but there are also examples of persistent price increases in sectors that have not suffered persistent cost increases, and these have an inflationary effect. the diagram shows the impact of excise tax increases on alcohol and tobacco industries, and that the energy and local authority sectors have recorded persistently high price pressures. given the fragility of the recovery it is important that firms base their pricing decisions on low underlying inflation, and not the forthcoming temporary spike. monetary policy would need to respond if inflation expectations and prices were ratcheted up significantly. the result would be higher interest rates and a dampening of the economic recovery. we are hopeful this will not need to be the case, so that monetary policy can play as full a part as possible in supporting economic growth.

in inflation, and lists changes in indirect taxes and significant government policy that directly affect prices as specific reasons why inflation might vary around its medium - term trend. as such, monetary policy will not attempt to offset the immediate direct inflation impact of the coming policy changes. given the staggered nature of the indirect tax increases and the progressive introduction of various sectors to the emissions trading scheme, there is an additional risk that the coming spike in inflation causes consumers and businesses to reassess their expectation of medium - term inflation. the degree to which monetary policy can “ look through ” temporary inflation spikes depends crucially on the extent to which new zealander ’ s inflation expectations are impacted by such spikes. of late, inflation expectations have risen from the lows seen at the trough of the recession but they remain contained. two - year - ahead inflation expectations initially lifted late last year, when there was some talk of the housing market gaining significant momentum again and the economy had clearly moved out of recession. subsequent to that we saw excise taxes rise, the ets - related charges become more definite and the announced rise in gst. all of these are likely to have played some part in inflation expectations staying up, even as the housing market has eased off and the pace of the recovery has remained moderate. however, the reserve bank does not expect the forthcoming price spike to have a lasting impact on inflation expectations. ( in support of this, the just - released aon survey shows that longer - term inflation expectations have not moved as a result of the impending gst increase. ) the gst increase in 1989 did not materially affect inflation expectations, and again we expect this to be the case in 2010. as in 1989, personal income taxes will be reduced on 1 october, offsetting the impact on disposable incomes coming from the gst increase. other temporary spikes in inflation have also not generally fed into inflation expectations and the reserve bank has been able to “ look through ” the immediate impacts of the price change. this is one of the big pay - offs of keeping inflation well anchored. nonetheless, the price and wage setting behaviour of firms and households will be monitored for evidence of indirect and second - round effects on inflation. for now, it is assumed that the coming policy changes will have only limited impact on perceptions of future inflation. the key to ensuring no significant effect on inflation expectations is for businesses, labour groups and households not to use the gst increase as a veil to increase margins and wages. doing