Recession May Lead Britain to Drop Zero-Inflation Goal

THE British government's long-held belief that achieving zero inflation will provide the launch pad for economic recovery - an article of deepest faith in the Thatcher era - is under challenge.

The questioning is coming from politicians and economic analysts who say the longest recession since World War II may deepen still further if the zero-inflation goal is not abandoned.

Roger Bootle, chief economist with the banking firm Midland Montagu, calls an inflation-free economy an "undesirable and unattainable aim." That goal was reaffirmed as an official Downing Street objective Aug. 14 by Anthony Nelson, a Treasury official.

But with unemployment at its highest level for five years and industrial production at a virtual standstill, Chancellor of the Exchequer Norman Lamont may be preparing to recast his economic strategy, including his commitment to try to achieve absolutely stable prices.

The Financial Times has reported that Mr. Lamont is close to abandoning his commitment to achieving a balanced national budget before the next general election. Lamont's officials denied the report, but some of his cabinet colleagues are privately urging him to run an annual deficit of around 40 billion British pounds (US$77 billion) until the next general election four years from now. Change may follow French vote

This would amount to a basic change of strategy for the ruling Conservative Party and could create inflationary pressures. Under Margaret Thatcher's tenure as prime minister, balanced budgets and low inflation were rock-solid policy. A more permissive approach to inflation may follow next month's French referendum on the Maastricht treaty on European union, senior Conservative parliamentarians say.

"If the French say yes to Maastricht, Mr. Lamont is likely to decide that inflation steady at around 2 percent is acceptable," says a former Treasury official.

Behind the speculation about an impending policy switch are a series of dismal economic reports:

* Unemployment has risen for the 27 months running to 2.75 million - one-tenth of Britain's work force.

* Industrial production in June rose by only 0.1 percent

* Banks reported that rather than extending their credit, consumers were paying back loans - a sign of low public confidence, the banks said.

It was the Aug. 14 announcement that inflation had fallen to 3.7 percent - the largest monthly drop in 25 years - that prompted questioning of the government's zero-inflation goal.

"Low inflation can be achieved if you are prepared to grind the economy down, and that is what is happening. Every person joining the dole queue costs the taxpayer 9,000 British pounds in benefits and lost taxation," said Frank Dobson of the opposition Labour Party.

Mr. Nelson, however, said the latest inflation figures were "very good news for the economy" and "a further sign that our strategy is on course."

Mr. Bootle says the government has no option but to review its economic policy in the context of membership in the European Community's Exchange Rate Mechanism (ERM).

"The chancellor can either slog on with current policies, which will mean very low inflation and also next to no growth, or make a radical breakout and either devalue the pound or withdraw from the ERM and slash interest rates," Bootle says. Currency ties with Europe

As a member of the ERM, Britain can realign its currency only with the agreement of its EC partners. Britain entered the ERM when the pound stood at 2.90 deutsche marks, and undertook to keep the rate above 2.78. It is now 2.82.

Bill Martin, chief British economist of the stockbrokers UBS Phillips and Drew, says adherence to the ERM is putting the British economy "in a straightjacket."

John Townend, chairman of the Conservative backbench economic committee concludes: "We are paying the price of German unification, and we are suffering from the fact that France is unwilling to talk about interest rates."

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