IJC H2 ECONS Case2 SuggestedSolutions

Question 2 Differing Policy Responses to Anaemic Economic Growth Table 1: Unemployment Rate (%) 2006 2007 2008 2009 2010 2011 2012 China 4.1 4 4.2 4.3 4.1 4.1 4.1 Japan 4.1 3.8 3.9 5.1 5 4.6 4.3 United Kingdom 5.5 5.4 5.7 7.7 7.9 8.1 8.0 Table 2: Real GDP Growth (%) 2006 2007 2008 2009 2010 2011 2012 China 12.7 14.2 9.6 9.2 10.5 9.3 7.7 Japan 1.7 2.2 -1.0 -5.5 4.7 -0.5 1.5 United Kingdom 2.8 3.4 -0.8 -5.2 1.7 1.1 0.3 Table 3: Inflation Rate (%) 2006 2007 2008 2009 2010 2011 2012 China 1.5 4.8 5.9 -0.7 3.3 5.4 2.7 Japan 0.2 0.1 1.4 -1.3 -0.7 -0.3 -0.0 United Kingdom 2.3 2.3 3.6 2.2 3.3 4.5 2.8 Source: IMF & World Bank Figure 1: Bank of England Interest Rates (%) Source: Bank of England 0 1 2 3 4 5 6 7 03-Jan-06 03-Jan-07 03-Jan-08 03-Jan-09 03-Jan-10 03-Jan-11 03-Jan-12

2 Extract 1: Creeping protectionism in EU trade policy Developing countries stand to lose out from trade reforms that are pushing the EU towards more protectionist policies, according to a report by the Overseas Development Institute (ODI). The first reform of the Generalised System of Preferences 1 (GSP) in 30 years, said the report, will see richer developing countries such as India and Vietnam lose trade concessions of up to €257m (£201m). Since 1971, the GSP has ensured that exporters from developing countries pay lower duties on some or all of what they sell to the EU, giving them vital access to European markets. With reform of the GSP, the EU is likely to impose more trade barriers on a range of products and countries where there isn't a reciprocal free-trade agreement with the union. "Upper-middle-income countries will still be eligible for preferential access to the EU market, but only if they agree to free-trade agreements, not by virtue of their WTO status as developing countries," said Stevens. The new EU trade policy also has a glaring omis sion, the EU's common agricultural policy, in which European farmers receive €50bn in subsidies. Such payments and export subsidies aimed at boosting the production and income of EU farmers tend to reduce world prices and the attractiveness of the European market for developing countries. "Designing a trade strategy in times of economic and financial crisis always carries a risk, and there will inevitably be winners and losers," said Dirk Willem te Velde, head of the ODI's international economic development group. "The clear protectionist trend in the EU's new strategy will not only damage the developing world, but also European economies and consumers." Source: www.theguardian.com, 27 Jul 2012 Extract 2: Japan's economic growth slows Japan's economy grew at a slower-than-expected annualised rate of 1.4% in April-June, adding to worries over the global outlook, as consumer spending flagged following an earlier rebound from last year's earthquake and tsunami. The eurozone crisis also took a heavy toll as feeble demand hit Japan's export sector. Although the pace of growth dropped sharply from a revised 5.5% in the previous quarter, the economics minister, Motohisa Furukawa, struck an upbeat tone, saying in a statement that the economy "continues in an uptrend, led by domestic demand". However, Nishioka, an economist at RBS Japan Securities, said the risk of worsening deflation was a "pessimistic result" that might prompt Japa n's central bank to consider further easing of monetary policy to support growth. Deflation is a chronic problem for Japan and can be a drag on economic growth. Consumer spending makes up more than half of Japan's economic activity. After the 11 March disaster last year, many Japanese held back on spending and excursions, adding to damage from disruption to manufacturing after many automotive and electronics plants ground to a halt in north-eastern Japan. 1 The EU Generalised System of Preferences offers generous tariff reductions to developing countries. Practically, this means partial or entire removal of tariffs on two thirds of all product categories.

3 Robust public investment in reconstruction of housing and other buildings in the devastated region is likely to wane in coming months, further reducing momentum. Meanwhile, the strong Japanese yen has clobbered exports, and costs for importing fuel to offset lost generation capacity from closed nuclear power plants have mounted. Japan's economy grew 0.3% in the quarter ending in June, from 1% in January-March. That was lower than economists' forecasts of more than 2%, and translates to a 1.4% expansion in annualised terms. Source: www.theguardian.com, 13 Aug 2012 Extract 4: End of inflation targeting? Mark Carney, the next governor of the Bank of England, mused on the need for central banks to be creative in the post-crisis world. Growth has been so slow that Carney, said that in certain circumstances policymakers might need to ditc h inflation targets and embrace nominal GDP targets instead. Here's why. In most years, the value of all the goods and services produced in an economy goes up. This is the increase in nominal gross domesti c product. Part of that increase is due to the fact things cost more than they did last year, and this is stripped out by statisticians to find how much the economy has really grown. In the UK and in many other countries, the job of the central bank is to prevent prices from rising too quickly. The Bank of England is obliged by law to try to hit a 2% inflation target. Inflation targeting is straightforward, at least in theory. The Bank of England forecasts the future path of inflation; the forecast is compared with the target inflation rate (the inflation rate the government believes appropriate for the economy); the diffe rence between the forecast and the target determines how much monetary policy has to be adjusted. Since the slump of 2008-09, this relationship between price stability and economic growth has broken down. The annual increase in the cost of living has tended to be higher in recent years thanks to rising global commodity prices, higher VAT and the depreciation of the pound. The assumption is that if inflation is under control, the economy will expand at its long-term trend rate of growth, which is in the region of 2-2.5%. If you add real growth of 2.5% to 2% inflation then nominal GDP should rise by, say, 4.5% a year. The Office for Budget Responsibility is forecasti ng nominal GDP will rise by just 2.2% this year and, with inflation running at 2.3%, that means, the economy is predicted to shrink by 0.1%. Inflation is under control but the economy is struggling. Now assume the government switches to a nomi nal GDP target of 4.5%. The Bank would have to adopt a more expansionary monetary policy – perhaps by increasing the size or scope of its quantitative easing programme – in order to boost the value of economic output. Crucially, the split between inflation and real output would not matter: in theory the whole of the 4.5% increase in nominal GDP could be the result of higher prices. Academics have been discussing the merits of nominal GDP targeting for some time. Carney's intervention suggests policymakers are starting to take notice of the debate. To an extent, this reflects the lacklustre recovery, but there is also a sense that inflation targeting only works well when economic conditions are benign. Adapted: www.theguardian.com, 12 Dec 2012

4 Questions (a) (i) With reference to Table 1 & 2, explain how recession affects unemployment rate. [2] (ii) Explain how you might use unemployment rate and real GDP growth to compare economic performance of China with that of Japan. [4] (b) (i) Explain the meaning of deflation. [1] (ii) Using AD/AS analysis, explain why deflation is a chronic problem for Japan. [3] (c) Explain how ‘strong Japanese yen has clobbered its exports’. [2] (d) Wi