Practise comparing contractionary monetary and fiscal policy with supply-side measures for demand-pull or cost-push inflation and evaluating transmission, time lags and output…
With the help of a diagram, assess the effectiveness of government policies that might be used to reduce demand-pull inflation.
OR
Use Table A: AO1 Knowledge and understanding and AO2 Analysis and Table B: AO3 Evaluation to mark candidate responses to this question.
AO1 and AO2 out of 14 marks. AO3 out of 6 marks.
Indicative content
Responses may include:
AO1 Knowledge and understanding and AO2 Analysis
- A clear outline of different causes of demand-pull inflation and why inflation might cause problems.
- A more detailed analysis of the causes of demand-pull inflation, can use either a monetarist or Keynesian approach, supported by an accurately labelled diagram
- A description of alternative policies that a government might use to reduce demand-pull inflation, can focus upon either a Keynesian or monetarist perspective
- Analysis can be used to show how a government will be able decrease aggregate demand, by appropriate fiscal policy. For example, by increasing direct taxation. This analysis might also be supported by a relevant diagram
- Alternatively, a government might focus on the use of different types of monetary policy. For example, increasing interest rates, re-valuing the currency or open market operations. Accept alternative supply side policies.
L2 Max if no relevant diagram provided
4
AO3 Evaluation
- Increasing the use of direct taxation might have a negative impact on long term economic growth and/or unemployment
- Decreasing government expenditure might mean key sectors such as education and health care having a long-term negative impact on social welfare
- The overall impact of contractionary fiscal policy will depend upon the state of the economy when the new policies were introduced.
- Exchange rate policies which promote a re-valuation of the currency might have a negative impact on an economy's balance of payments, depending upon the Marshall-Lerner condition. This might also cause unemployment in the export producing sector.
- The use of high interest rates might lead to lower levels of investment which, in turn, will have a negative impact on economic growth in the long term
- A contractionary monetary might also produce additional economic outcomes. For example, a rapid fall in house prices due to the high cost of borrowing for house purchase.
- A conclusion should attempt to assess the relative effectiveness of each type of policy approach and consider which approach is likely to be the most effective in the short run and then compare this with possible outcomes that might be achieved in the long run.
Accept all valid responses.
AO1 Knowledge and understanding and AO2 Analysis
AO3 Evaluation
OR