Summary macroeconomic issues

This summary note addresses three topics; inflation, balance of payment and exchange rate. These represent three major macroeconomic issues. Other macroeconomic issues include unemployment, growth and development.

(a)    Inflation

Inflation is the persistent rise in the average price level. What you need to know.

1.      Causes of inflation; demand pull (cause by too much spending in the economy especially when consumers have excess cash to spend in the economy/economy is doing well/booming), cost push inflation (rising cost of production due to wage hikes, oil price hikes etc) and extensive increases in the money supply (remember Germany in the 1920s). (Remember how to draw the diagrams to illustrate inflation).

2.      Consequences of Inflation – inflation could have many harmful effects with some positive effects.

causes poverty as cost of living increases – so the low income groups are worse affected, loss of confidence in the local currency which could lead to a run on the banks as people try to withdraw their entire life savings, savers are affected, less investment as banks are less able to give loans when people are saving/depositing little, pensioners with fixed income are affected, lenders are affected while borrowers gain, shoe leather effects as consumers search for better deals, menu effects as firms have to constantly change their price tags.

(b)   Balance of Payment

Balance of payment focuses on current accounts problems. Make sure you know that.

1.      What causes BOP disequilibrium/current account deficit; limited exports (lack of economic diversification), too much importing etc. 2. What can be done to address BOP disequilibrium (current account deficit)? i.e. economic diversification, trade barriers e.g. tariffs, subsidy and quotas, demand management policies (see mark scheme for ER for distinction between expenditure switching and expenditure dampening). N.B. These policies are not always effective.

(c)    Exchange rate – 1. types of exchange rate; fixed, flexible/floating and managed float (managed float is not the same as flexible/floating exchange rate); 2. How are they determined and illustrate these (using graphs) N.B. Fixed, determined by central bank/government and with this system government engages in constant open market operations i.e. buying the currency using foreign currency when the demand for the currency is low and it is losing value and selling the currency to purchase foreign currency when the currency is increasing in value. Flexible determine by market forces and explain what these are (diagrams). Manage float adopts elements of both (see your notes for diagram. 3. What is meant by devaluation/depreciation? 4. What is meant by revaluation/appreciation? 5. What are the advantages and disadvantages of both extreme types of exchange rate regimes?