IB Economics SL 3.5.4 Real and Nominal Interest Rates Questions

Read the extracts and answer the questions that follow.
Text D - Overview of Cameroon

Read the extracts and answer the questions that follow.
Text D - Overview of Cameroon

Read the extracts and answer the questions that follow.
Text D - Overview of Cameroon

(1) Cameroon is a country in Central Africa with a population of 25 million. It is rich in natural resources, including oil and mineral ores, and produces a wide range of agricultural products, such as cotton and cocoa. Its economic growth is usually driven by the export of oil. The gross domestic product (GDP) of Cameroon grew by an average of 5.6 % per year between 2013 and 2014 when oil prices were high.

(2) Economic growth slowed and the budget deficit increased sharply between 2014 and 2016, when oil prices fell by 45 %. Oil production is a major part of the formal economy and is an important source of tax revenue for the government of Cameroon. Up to 90 % of the workers in other sectors are employed in the informal economy and hence contribute significantly less to tax revenue. Increased military spending in response to recent conflicts in the western regions of Cameroon further widened the budget deficit.

(3) Since the collapse of oil prices, economic growth has been supported by expansionary fiscal policy, which has become increasingly difficult to sustain. The budget deficit has increased to around 5 % of GDP and caused government (national) debt to rise to 30 % of GDP.

(4) Although there has been some reduction in absolute poverty in Cameroon, the number of people living in relative poverty increased by 12 % to 8.1 million between 2007 and 2014. The funds allocated for poverty reduction often go to subsidies for electricity, food and fuel. This reduces available funding for education and healthcare, which is insufficient in rural areas where poverty is most extreme.

(5) With an abundance of natural resources, Cameroon has the potential to attract foreign direct investment (FDI). However, weak governance and the poor business environment have deterred foreign investors. Local entrepreneurs are also discouraged by the long wait times for obtaining licenses to operate and the difficulties in securing business loans.

(6) Cameroon maintains a fixed exchange rate to the euro, at 1 franc =0.0015 euro. Because of the persistent trade deficit, the franc (Cameroon's currency) is overvalued at this level. Interest rates are kept high to prevent capital flight, which could increase the currency's overvaluation.

Text E - The Growth and Employment Strategy

(1) The Growth and Employment Strategy is a set of policies adopted by the government of Cameroon to encourage diversification and promote efficiency in production. The policies have three broad objectives:
- Create jobs and reduce the size of the informal economy through investment in human capital.
- Increase productivity in agriculture, mining, and selected industries with potential for growth (timber, tourism, and information and communication technologies).
- Encourage private investment and trade through the provision of infrastructure (including roads, ports and clean water supply).

(2) Productivity is low, especially in the primary sector. Cameroon has one million small farms engaged in traditional agriculture, but has a limited number of workers trained in good farming practices and management skills. Unskilled workers often work in the informal economy.

(3) Access to imported fertilizer and lower transportation costs could reduce costs of production significantly. Farms also need to increase productivity to reduce labour costs. The monthly agricultural wage averages 20000 francs but the government has recently increased the minimum wage to 36270 francs. This could lead to an improvement in the economic well-being of workers in the formal economy but could increase unemployment and force some workers to enter the informal economy.

(4) The government remains committed to keeping food prices low in the short term through subsidies. Due to improved farming methods, farmers produced better quality cocoa beans in 2019, allowing them to charge higher prices on the international market. Over time, the increase in productivity should lead to higher incomes, lower prices and higher-quality products.
Text F - Free trade agreements with the European Union (EU) and the United Kingdom (UK)
Cameroon has signed free trade agreements with the EU and the UK, which allow tariff-free access to the EU and the UK markets for products such as bananas, aluminium and processed cocoa products. Tariffs on imports into Cameroon of machinery and equipment, vehicles and fertilizers were also removed. However, tariffs on textiles and strategic agricultural products such as meat products, milk and selected vegetables were maintained.

* charged by financial institutions on loans

Using the information in Table 3 and your answer to (b)(i), calculate the real interest rate in Cameroon in 2019.