6EC02 Jan 2012 Model essay

With reference to Extract 2, evaluate the likely impact of higher inflation on THREE macroeconomic objectives

Introduction
Define Inflation - rise in general price level over time (2 marks). In Extract 2 UK inflation as measured by CPI is above target i.e. above £ % (2 data). Macro objectives are: low unemployment, low and stable inflation, sustained growth and avoiding a large and persistent trade deficit. In addition inequality and the environment can also be considered.

Higher inflation in the UK will make UK exports uncompetitive as Uk prices are rising around 3% on average whereas the euro countries prices are rising around 1.9% and therefore this will increase the UK's trade deficit (Point 2 marks and explained 2 marks). However the pound is getting weaker so this may make UK exports cheaper (2e) and also recovery elsewhere in the world e.g. USA might mean that other countries inflation is increasing as much as the UK's  (2e+).

Higher inflation in the UK above target will force the Bank of England to increase interest rates to curb this increase. As interest rates rise consumption and investment will fall resulting in recession. However the data says that the Bank of England are confident that inflation will fall back to 2% target (2e) so they will not increase interest rates (2e). However less consumption may help the environment (2e).

Higher inflation will erode the value of savings so rich people as savers will lose out and those on low income that have borrowed money will win, as they owe less in real terms, this may close the gap between the rich and the poor thereby reducing inequality. However the savings of rich people might be index linked to inflation thus preventing their savings from falling in value. (2e) Also low income people may not have their wages or benefits linked to inflation (index linked) so the cost of living may rise substantially for them. (2e)