CAIE IGCSE Economics 4.3 Monetary Policy Topic Practice

What is the money supply?

There are several policy measures a central bank or government can use to reduce unemployment. One policy measure a government could use to reduce unemployment is to increase its spending on building houses. The Federal Reserve, the central bank of the US, has two main aims. One is to maintain price stability and the other is to achieve full employment. Some central banks also have economic growth as a target, but none have HDI value as a target.

Identify two policy measures a central bank could use to maintain price stability.

Read the source material carefully before answering Question 1.

Although inflation in Switzerland in 2022 was above its target of $2 \%$, it was below the inflation rate of other high-income economies, such as the US ( $9.1 \%$ ), the UK ( $11.1 \%$ ) and Germany ( $7.9 \%$ ). Price levels are more stable because of a combination of microeconomic and macroeconomic policy measures. These include maximum prices, subsidies and a contractionary monetary policy.

To encourage the production of solar energy, the Swiss Government has provided more than $\$ 500$ million in subsidies to producers. This is part of the government's plan to move away from non-renewable sources of energy which are mainly imported. Overdependence on foreign markets could lead to the economy becoming more exposed to external shocks.

Switzerland's current account of the balance of payments has been in surplus from 2015 to 2022. Low inflation, along with the production of very high-quality products, may have contributed to this surplus. A strong currency has also kept the cost of imported raw materials low in Switzerland.

The Swiss franc is one of the more stable currencies in the world. During times of economic uncertainty, the Swiss franc usually strengthens. Fig. 1.1 shows global growth rate (\% change in GDP) and the percentage change in the value of the Swiss franc, against the USD($), from 2018-2022.

Although inflation was not high compared to other countries, the Swiss central bank increased interest rates in 2022. This was done to reduce inflationary pressures. However, there was a risk that higher interest rates might increase unemployment.

The rise in interest rates affected some firms negatively. The Swiss Government had to organise a merger between the two largest banks in Switzerland. This was to avoid one of them collapsing which would have reduced confidence in the whole banking system. A merger might also have helped the merged bank to gain greater economies of scale. However, the merger resulted in some workers losing their jobs and gave the merged bank greater monopoly power.

Discuss whether or not an increase in interest rates will harm the Swiss economy.