TMJC 2022 A Level H2 EQ5

2022 A Level H2 Economics Suggested Answers to Paper 2 EQ5 © TAMPINES MERIDIAN JUNIOR COLLEGE Essay Question 5: A low rate of inflation is a key macroeconomic policy objective for most governments. During the first quarter of 2020, interest rates in most countries throughout the world fell to very low levels. (a) Explain why a rise in interest rates is used as a macroeconomic policy tool to control inflation in some countries but not in Singapore. [10] (b) Discuss whether a change in interest rates in other countries is likely to have a significant impact on Singapore’s domestic and external economy. [15] Part (a) Suggested Answer Introduction • [recognise that interest rate is a tool of monetary policy (MP) and define MP] Interest rate is one of the main tools of monetary policy used by large economies such as US, UK, the Eurozone and Japan. Monetary policy is the manipulation of monetary variables such as money supply, interest rate and the exchange rate to influence aggregate demand to achieve macroeconomic objectives such as economic growth, price stability, full employment and a favourable BOT. • [note the difference between choice of MP between other countries and SG] However, the choice of instrument depends on the nature of the economy. Development #1: Explain why a rise in interest rates is used as a macroeconomic policy tool to control inflation in some countries like the US • For many large countries such as the US / UK which depends on domestic demand such as domestic consumption and investment to drive growth, it is relatively easier to implement contractionary monetary policy (raising interest rates) as compared to a contractionary fiscal policy to address the problem of demand-pull inflation due to overheating. This is because it is relatively easier to adjust interest rates than to approve of changes in government spending and taxation, the latter is often facing more resistance from the public especially when the government is trying to cut back on public spending and increase taxes. • Interest rates represent the cost of borrowing as well as the returns to savings, which the Central Bank aims to control to regulate the level of borrowing and hence AD in the economy. For example, the Central Bank (Federal Reserve) can deliberately raise interest rates to prevent overheating of the economy and achieve price stability. When interest rate increases, households will decrease consumption for two reasons: - The returns on saving money has risen or the opportunity cost of spending has increased. Hence, households will be incentivised to save rather than spend. - The cost of borrowing money for expensive purchases (such as houses and cars) has risen. Hence, households would not be attracted to borrow money to fund these purchases.

2022 A Level H2 Economics Suggested Answers to Paper 2 EQ5 © TAMPINES MERIDIAN JUNI