Economics 9708/21 — October/November 2021
Cambridge AS Level · AS Level Data Response and Essays · worked solutions for every part, with the mark scheme
Topics Monetary Policy · Price Stability · Market Equilibrium and the Price Mechanism · (Legacy) - Money · Aggregate Demand and Aggregate Supply · Production Possibility Curves · +7 more
What is the ‘right’ level of inflation?
Central banks aim to keep inflation under control, but what does ‘under control’ mean? How much inflation is too much? And, a question only an economist could ask, how much inflation is too little?
Hyperinflation, where the rate of inflation is extremely high, is an economic catastrophe for a country. Table 1.1 below gives details of four cases of hyperinflation.
Table 1.1
| Country | Date | Highest monthly inflation rate (%) | Time taken for prices to double (hours) |
|---|---|---|---|
| Hungary | 1945 to 1946 | 41900000000000000 | 15 |
| Zimbabwe | 2007 to 2008 | 79600000000 | 25 |
| Germany | 1922 to 1923 | 29500 | 89 |
| Venezuela | 2016 to 2018 | 219 | 430 |
Source: www.cato.org/research/world-inflation-and-hyperinflation-table, accessed October 2019
The consequences of hyperinflation are far-reaching. Inflation undermines the functions of money. Rapid price rises encourage panic-buying by consumers, creating shortages that further increase inflation. In the most extreme cases countries stop using money completely, and resort to barter. In Zimbabwe, hyperinflation led to the abandonment of its currency in 2008 and the use of the US dollar as an alternative. More recently, Venezuelan restaurants and supermarkets stopped displaying prices and consumers only found out the value of their purchases at the checkout.
To avoid the consequences of high inflation, central banks often set a low ‘target’ rate of inflation, typically around 2% a year. But this policy has also been criticised by some people. If central banks follow such a target the outcome would be to erode the real value of money over time. Central banks have often been instructed by governments to have an inflation target, and yet even a 2% inflation rate will halve the real value of money in 36 years.
Central banks can use high interest rates as a tool of monetary policy to keep down the rate of inflation, but very often monetary policy requires low interest rates to stimulate consumption spending and investment in an economy.
It should not be forgotten that there are potential benefits of relatively low levels of inflation and this is why some countries have an inflation target of, say, 2%. A former chief economist of the International Monetary Fund even suggested that many countries’ inflation target should be 4% rather than 2%.
Source: Adapted from The Times and The Financial Times, both 9 February 2019.
Explain how inflation can halve the ‘real value’ of money.
With the aid of a diagram, explain why ‘rapid price rises encourage panic-buying by consumers, creating shortages that further increase inflation’.
With reference to one function of money explain why hyperinflation in Zimbabwe caused the country to abandon its currency in 2008.
Using aggregate demand and aggregate supply analysis, discuss whether it is possible to use monetary policy to achieve both a high level of investment and a low rate of inflation.
Discuss whether everybody in an economy such as Venezuela would be worse off as a result of hyperinflation.
The rest of this paper
3 more questions- Q2Production Possibility Curves · Economic Systems20M
- Q3Methods of Government Intervention in Markets · Elasticities of Demand · Price Elasticity of Supply20M
- Q4Exchange Rates · Balance of Payments · Fiscal Policy · Monetary Policy20M