Explain how monetary policy affects demand, output, prices and employment through interest rates and the monetary transmission mechanism.
Read the extracts and answer the questions that follow.
Text A — India-United Kingdom trade agreement negotiations
Read the extracts and answer the questions that follow.
Text A — India-United Kingdom trade agreement negotiations
(1) India is a country located in South Asia. India's government predicts 7 % annual economic growth and it is expected to become the third-largest global economy by 2030. To support growth, India is establishing trade agreements to diversify trade partners, and reduce the impact of global political and economic shocks. However, the annual inflation rate increased from 4 % in 2021 to 7.8 % in 2022 due to supply chain issues and oil price increases. In response, India's government has reduced taxes on fuel while the central bank has tightened monetary policy.
(2) The United Kingdom (UK), a country in Europe, needs trade agreements with countries in Asia as this area contains some of the world's fastest-growing economies and represents over 40 % of global gross domestic product (GDP). It is currently negotiating a free trade agreement (FTA) with India, which aims to double trade between the two countries by 2030. The agreement is also expected to increase labour movement and job opportunities and protect intellectual property. The Indian government is negotiating easier access to UK work permits and student visas but is concerned that some of its citizens may not return home with their skills.
(3) The India-UK FTA would reduce trade protection, including tariffs and quotas, and administrative barriers. India expects to increase its exports of textiles, leather goods, footwear, and pharmaceutical products, whereas the UK aims to boost its exports of British cars, wine, spirits and vinegar. Additionally, foreign direct investment (FDI) between the two countries is expected to increase. The FDI inflows could help to finance India's large current account deficit, which has increased as worker remittances from abroad have fallen. However, the current account deficit may decrease anyway because of recent increases in portfolio investment outflows, which could also impact the value of the rupee (India's currency).
(4) Increased competition from UK imports may threaten the growth of infant industries in India. An example is the local wine industry in India, which has grown by 30-40 % in recent years. However, to protect infant industries, the reduction in tariffs will be gradual and business taxes will be lowered.
(5) Another discussion area in India-UK trade negotiations is the possible privatization of essential services in India, such as healthcare, education, and water. There has been encouragement from the UK for India to open these markets to foreign investment and competition.
(6) Increased trade and competition could lower prices, forcing firms to cut labour costs. Indian labour protection groups want the UK to stop trade talks until India changes a law restricting labour unions. They believe the trade agreement should include regulations to protect against poor working conditions and low pay, which impact gender inequality and child welfare.
Text B - India-UK trade negotiations and Sustainable Development Goals
(1) India and the UK recognize the relationship between trade and sustainable development and are committed to supporting the sustainable development goals (SDG).
(2) The India-UK FTA negotiations are encouraging collaborative research and development projects in the following areas:
- Clean energy and green technologies; decreasing the market failure associated with fossil fuel energy, developing electric vehicles, and waste management practices.
- Gender inequalities; improving access to credit and markets for women, improving education opportunities, and increasing labour participation rate of females in India.
- Human and labour rights; supporting programmes that create work opportunities and better working conditions.
- The agricultural sector and food security; addressing India's low productivity rates, which are blamed on ineffective fertilizer subsidies, lack of infrastructure, and flooding and drought problems from climate change.
- The healthcare sector; developing pharmaceutical products.
Table 1: Development data for India
(3) India-UK's previous health sector collaboration resulted in global vaccine development and helped decrease the market failure in the industry. However, possible FTA intellectual property rules may limit India's ability to produce low-price medication, resulting in reduced export opportunities and possibly creating monopolies. On the other hand, targeted research and development could lead to cheaper medication, and the UK's insurance expertise may improve India's health insurance programme.
(4) Growth in India-UK trade may increase carbon emissions, deforestation, and air and water pollution. Experts estimate the FTA could increase trade-related transport emissions by up to 36 %. Environmental experts believe this is significant as the UK continues cutting solar panel subsidies, slowing the conversion to clean energy.
Table 2: India and UK SDG data in 2021
Table 3: India's SDG progress in 2021
Table 4: Economic data for India
Define the term monetary policy indicated in bold (Text A, paragraph 1).
Sketch an AD/AS diagram to show the possible impact on India's inflation rate of a tighter monetary policy (Text A, paragraph 1).
Read the extracts and answer the questions that follow.
Text D - Overview of Cameroon
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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.
Table 3: Selected data for Cameroon
* charged by financial institutions on loans
Table 4: Cameroon's main export markets (2019)
Using the information in Table 3 and your answer to (b)(i), calculate the real interest rate in Cameroon in 2019.
Read the extracts and answer the questions that follow.
Text A - Overview of the economy and government policies in Kenya
Read the extracts and answer the questions that follow.
Text A - Overview of the economy and government policies in Kenya
(1) Kenya, in East Africa, is achieving high annual economic growth rates, averaging above 5 %. Living standards are improving and employment is increasing in the manufacturing, tourism, construction, and education sectors. Kenya's high growth is also changing the distribution of income and affecting the environment. However, climate change, high levels of inequality and youth unemployment may reduce future growth rates.
(2) Floods and droughts are severe and frequent. In 2022-2023, droughts caused agricultural output to fall, affecting the employment of 40 % of the population and doubling the number of people with insufficient food. The government took measures to increase food supplies, such as reducing the tariff on imports of rice. It did not impose a price ceiling for essential food, as food shortages might result.
(3) The rising price of food is the main cause of inflation in Kenya. The central bank used a contractionary monetary policy in 2022 and 2023 to reduce inflation and to prevent the depreciation of the country's currency (Kenyan shilling, KES).
(4) The budget deficit as a percentage of gross domestic product (GDP) became smaller in 2023 because government expenditure grew more slowly than GDP. Moreover, economic growth resulted in higher tax revenue from both income tax and a 16 % indirect tax on goods and services. The government is also receiving revenue from the sale of some state-owned enterprises (SOEs). A World Bank programme, aimed at an expansion of "green" energy in Kenya, provides financial and technological support to the Kenya Power and Lighting Company, an SOE that has been making losses.
(5) The currency depreciation in 2022 boosted exports. Services, which are approximately 38 % of total exports and include tourism and financial services, are growing faster than exports of goods. Manufactured goods account for 37 % of total exports and agricultural goods account for 25 %. Revenue from exports of tea, flowers, vegetables, meat, and coffee are volatile and unpredictable. The droughts in 2022-2023 reduced output, which lowered export revenue from vegetables and flowers by almost 20 %.
Text B - Unequal distribution of the benefits of economic growth in Kenya
(1) Although economic growth has reduced absolute poverty, inequality remains a problem, particularly between the formal and informal sectors and between the urban and rural areas. Rural poverty is caused by low agricultural productivity and farmers' limited access to markets, finance, and technology.
(2) However, the level of education has improved significantly, with a literacy rate of over 90 %. Secondary school attendance rates have increased from 13 % in 2003 to 49 % in 2022, despite the costs of attending school. In 2022, the government introduced a fund (the Hustler Fund), partly financed by foreign aid. The fund provides low-interest loans to women, young people, and small firms, for education or investment.
Text C - Reducing and adapting to climate change in Kenya
(1) Global warming is affecting the Kenyan economy. Consequently, agricultural output and tourism, which account for 70 % of employment and most exports, will probably decline. Therefore, GDP could fall by 2 % annually. However, Kenya has relatively low carbon emissions, particularly because renewable resources generate 90 % of electricity, a figure that is planned to rise to 100 % by 2030.
(2) Measures taken by other economies to reduce carbon emissions provide opportunities for Kenya because the markets for "green" goods are expanding. Kenya is able to sell tradable permits (carbon credits) to high-emitting countries due to its reforestation programmes.
(3) The International Monetary Fund (IMF) recommends that climate-related considerations should be part of macroeconomic and infrastructure policies. It also recommends that carbon taxes should be imposed to reduce the use of fossil fuels by manufacturing firms. Rapid urbanization is increasing the need for electric vehicles and improved public transport. Energy efficiency measures, fuel substitution, and switching to rail transport will not only lower transportation costs but also reduce the trade deficit. This is because fossil fuels used for transportation and manufacturing are imported.
(4) Kenya is able to obtain finance and technology for investment in climate-related projects, such as renewable energy and forestry programmes, through foreign aid and partnerships with the private sector. Overall, these policies will reduce environmental disasters and increase economic growth and jobs in the formal sector.
Table 1: Balance of payments accounts for Kenya in billions of USA dollars (USD)
Table 2: Economic data for Kenya
Table 3: Development data for Kenya
Using an AD/AS diagram, explain why a contractionary monetary policy may reduce inflation in Kenya (Text A, paragraph 3).