May's inflation rate, the highest in the Republic since 1985, has caused consternation and a degree of hysteria, prompting calls for the Government to do something.

The speed of the deterioration in inflation is certainly unsettling (it was only 1.5 per cent as recently as October), but the biggest risk to the economy right now is that which could follow panic policy responses: history suggests that hasty decisions taken to meet perceived crises can often have perverse effects.

The Irish housing market represents a good recent example of this phenomenon. Around half of the rise in inflation since October is due to housing costs, largely stemming from higher interest rates, now determined by the ECB and therefore beyond the Government's remit.

If one excluded mortgages, inflation has risen by two percentage points since October, from 3.2 per cent to 5.3 per cent, and it is useful to break down this rise into its component parts.

The biggest contribution came from tobacco, adding up to one third of the total rise, largely due to the December Budget, which hiked duties on cigarettes.

The oil price was the other main culprit as higher energy costs accounted for another quarter of the rise, so 60 per cent of the deterioration in underlying inflation can be put down to just two factors, higher taxes on cigarettes and higher oil prices.

Drink contributed another 10 per cent of the rise, as did services, with neither as dramatic as one might gauge from the political reaction to the May inflation data, particularly in relation to drink.

Yet the Government may wish to take some action in order to placate those who signed up for the Programme for Prosperity and Fairness (PPF).

VAT changes have been suggested by some, but there are a number of problems with this. In the first place, a 1 per cent cut in the standard rate of 21 per cent would trim less than half a percentage point off the inflation rate, and even this assumes all of the cut is passed on, which is certainly not inevitable.

The second point is that the Government is constrained by EU laws on the VAT changes it can introduce.

Third, petrol prices account for 4 per cent of the consumer price index (CPI) so it would require a 25 per cent fall in the price of petrol to cut inflation by 1 per cent.

Public transport fares account for 1 per cent of the CPI, so again, action to cut these would have only a very limited impact on the inflation data.

The reality is that inflation will decline anyway later in the year and into 2001, with the speed of deceleration depending on the price of oil, the euro and the 2001 budget.

The Minister for Finance can reduce inflation by 0.8 of a percentage point in December by leaving cigarettes taxes unchanged in the budget and reversing the previous rise at that time would reduce inflation by 1.6 percentage points. However, do we really want to cut the price of cigarettes?

A better response, albeit less immediate, is to take action to deregulate and encourage competition across a swathe of the economy, from transport, through the drinks industry to professional services, but this necessitates taking on vested interests, and as such requires political courage.

Another straightforward step would be to take action to encourage savings: low interest rates and accelerating inflation encourages borrowing and spending.

A number of policy initiatives spring to mind: the reduction or abolition of withholding tax on deposits; an increase in the after-tax interest on An Post savings; a tax package to encourage flows into other private sector savings and investment products; and a rise in the tax-free contributions payable into personal pension plans.

Furthermore, a strong Government message designed to influence the public's expectations on inflation would not go amiss, and at its core it should carry a firm commitment on public-sector pay.

Another high-profile pay settlement miles above the norms laid down under the PPF would fuel expectations that the recent rise in inflation is not a short-term phenomenon.

The Government may not be able to effect much in the economy anymore, but it must control that which it can - public-sector pay.

Finally, on a broader issue, the inflation data may help to bring to a head the immigration issue. Ultimately, higher inflation is the mechanism, which slows the economy as the market runs out of labour.

Allowing more non-Irish workers into the economy will help to keep inflation low but clearly carries other implications for society. In that sense, the inflation data should prompt a debate which is wider than whether to tweak VAT rates.

Dr Dan McLaughlin is chief economist at ABN-Amro Group