THE Rudd Government has been delivered another warning about the inflationary impacts of its $31 billion personal income tax cuts and the need to tighten its budget spending - this time from the OECD.

THE Rudd Government has been delivered another warning about the inflationary impacts of its $31 billion personal income tax cuts and the need to tighten its budget spending — this time from the OECD.

The warning comes a day after the minutes of the Reserve Bank's November board meeting were released, showing that the central bank had discussed the impact of fiscal policy on the economy.

The minutes noted that the tax cuts and election promises had reduced the forecast budget surplus and, therefore, were working against the bank's efforts to slow demand and inflation.

The Organisation for Economic Co-operation and Development yesterday released its international economic outlook.

It includes growth and inflation forecasts for Australia, as well as major players, including the US and China.

The report said that while the OECD was entering its fourth year of above-trend growth, activity was slowing due to cooling housing markets, including in the US, higher oil prices, and greater financial turmoil.

It said Australia's economic growth is likely to ease from about 4.5% to 3% by 2009, due to the impact of interest rate rises.

Inflation will ease from 3% to 2.5% between 2008 and 2009, but the risk was greater domestic demand and capital investment that would fuel the economy and inflation. It said the unemployment rate might increase slightly.

The report said that prudent budget management would "help moderate the pressures in capacity that may be heightened by the announced tax cuts".

Treasurer Wayne Swan has defended Labor's $31 billion tax cuts, saying that they will help increase workforce participation. But he also acknowledged the need for a tight budget.

"While the OECD paints an optimistic picture of growth, it also confirms the scope of the inflation challenge we have inherited and the difficult long-term task ahead," Mr Swan said. "My No. 1 priority is fighting inflation and delivering on our commitment to strict fiscal discipline."

The OECD acknowledges that tax cuts will eventually increase job participation and says it is important "to continue to stimulate labour supply, especially with respect to skilled labour", but this comes at a cost.

It said the 2007-08 budget, which included income tax cuts and major investments in education and transport infrastructure, had a surplus of 1.25%.

It predicted a 1% surplus for 2008-09, "following the additional reduction of taxes on households announced by the main political parties" during the election campaign.

The economy would still remain strong but, the report said, the fall could "induce a slight short-term expansionary effect".

The Reserve Bank had suggested a surplus of 2.5% was possible in 2008-09 if the spending promises had not been made.

The OECD also predicts that exports will bounce back, despite the higher exchange rate. The forecast follows the release of figures this week showing a $3 billion trade deficit. The organisation also expects the job participation rate to increase because of the Welfare to Work program announced by the Howard government last July.

It said there was the possibility of financial market volatility following the US loans crisis. It urged China to float its currency and redirect public spending to meet social needs.