Unit 2 Essay Question : May 2001 Q2

May 2001 Q2 :

Examine the impact of a decision to raise interest rates in an economy where there is both a high rate of inflation and a large current account deficit. Specific reference should be made to the exchange rate in your answer.

A rise in interest rates will reduce (candidates may use either the level, or the rate of growth of) aggregate demand. Consideration of likely transmission mechanisms: candidates should consider the impact on at least two elements of C+I+G+X-M.

  • An appropriate AD/AS diagram is also required.
  • Identifying income effects on inflation/current a/c
  • Identifying exchange rate effects on inflation/current a/c

Evaluation points might include:

  • More extended analysis of the impact of the changes already
  • The relative strengths of the various income and price effects identified
  • Other things may not be equal,
  • The shape of the AS curve (elasticities).