Practise policy-limit evaluation by linking central-bank decisions and external shocks to uncertainty, timing and data problems.
Sources for use with Section B
Inflation and labour markets in developed economies
Figure 1 Annual inflation rate for selected countries (%), as measured by the consumer price index (CPI), Q1 2020–Q4 2021
Sources for use with Section B Inflation and labour markets in developed economies Figure 1 A nnual inflation rate for selected countries (%), as measured by the consumer price index (CPI), Q1 2020–Q4 2021 7 6 5 4 % 3 2 1 0 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 2020 2020 2020 2020 2021 2021 2021 2021 New Zealand United States of America United Kingdom
Extract A Rising rates of inflation In 2021 many developed countries experienced an increase in the rate of inflation. Average price levels increased as a result of disruptions to global supply chains. These were caused by restrictions that had been in place during the global health crisis. As developed countries eased these restrictions, demand for goods, services and energy 5 increased. There was also a significant rise in average house prices. Rising rates of inflation are a challenge for central banks, especially for developed countries that have an inflation target of 2%. The central banks of these countries can adjust their monetary policy instruments to meet this target. Nevertheless, these instruments are less effective in tackling inflation created by a lack of supply. 10 There are problems facing central banks when applying monetary policies to reduce the rate of inflation. One problem is the inability of policymakers to control the rising rate of inflation caused by external factors. Another problem is estimating whether the increase in the rate of inflation is temporary or permanent. Policymakers who believe that this is a temporary issue suggest that the rise in the rate of 15 inflation is as a result of short-term external shocks. They attribute it to a one-off increase in supply chain disruptions and a one-off increase in consumer demand. By contrast, policymakers who believe that this is a permanent issue indicate that the increase in the average price level is a result of rising wages.
Extract B Labour markets Many developed countries have ageing populations and a falling proportion of people of working age. Since the global health crisis there has been instability in global labour markets. Many workers have retired early whilst others have left the workforce to focus on other personal objectives. There has also been a decline in international migration. As 5 a result of this fall in the labour supply, many companies have been forced to decrease production. This represents a considerable threat to global economic recovery. The critical question is whether workers will rejoin the labour force or whether employers and policymakers will need to adapt to a world in which labour becomes an even scarcer resource. In the USA more than four million workers have left the labour force since the 10 crisis. However, employment in the eurozone has almost returned to its pre-crisis level and the labour force participation rate has risen rapidly. For example, in France and Spain this rate is already higher than it was before the crisis. Employers are preparing for a future in which they will need to offer greater incentives to attract more workers back into the labour market. 15
Examine two 'problems facing central banks when applying monetary policies to reduce the rate of inflation' (Extract A , lines 11-12).
Knowledge 2, Application 2, Analysis 2, Evaluation 2
Quantitative skills assessed:
QS9: Interpret, apply and analyse information in written, graphical, tabular and numerical forms.
Knowledge and analysis
Up to 2 marks for identifying two problems and up to 2 marks for linked explanations, e.g.:
- Inability to control the rising rate of inflation caused by external factors/shocks (1): may occur while policies are implemented or having their full impact, e.g. changes in exchange rates, prices of commodities, economic conditions in economies of main trade partners (1)
- Difficulty in knowing whether the increase in the rate of inflation is temporary or permanent (1): because inappropriate policies could be applied, e.g. significant rise in base interest rate would not be appropriate if the inflation was temporary (1)
- Inaccurate information (1): issues with estimating/sampling, time delays/time lags, inadequacy of information gathering systems and processes, shadow economy/informal sector (1)
- Risks and uncertainties (1): the effects of policies may be difficult to predict either due to a lack of information as to consumers' and/or firms' reactions (1)
Application
Up to 2 marks for application from Extract A (1+1), e.g.:
- Temporary issue: as a one-off increase in supply chain disruptions / one-off increase in consumer demand (1)
- Permanent issue: as a result of rising wages (1)
Evaluation
Up to 2 marks for evaluative comments:
- Different factors will be more important in different economies (1) e.g. countries with proportionally larger shadow economies, less likely to have accurate information etc. (1)
- Other policies e.g. reflationary fiscal policy (1) might offset the impact of deflationary monetary policy (1)
- Information may be becoming more accurate over time (1) as technology and economic understanding improves (1)
- Historical data/information available on policy impact in the past (1) so not a significant issue to policymakers (1)
(8)
Question
With reference to Extract B, discuss how demographic factors may constrain economic growth of developed economies.
Indicative content