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Introduction to Macroeconomics - Case Study Example

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Introduction to Macroeconomics A) Why is it considered necessary to control the rate of inflation? It is necessary to control the rate of inflation for its several harmful effects as described in the following paragraphs (Parkin, 2010). Impact on Purchasing Power With the inflation rate gyrating upwards, real wages of the person fall leading to reduced purchasing power…
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Introduction to Macroeconomics
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Introduction to Macroeconomics

Download file to see previous pages... Moreover, there are always huge numbers of people that are self-employed and every one cannot increase their incomes in proportion to the inflation rate so a huge chunk of citizens suffer in this process. In a way, high inflation impacts living standard of the majority of the people. Impact on Interest Rates Bank interest rates get impacted due to high rate of inflation because banks need to enhance their deposit rates to attract the deposits from the public; moreover, this will also cause lending rates to go up. This puts producers and traders at inconvenience as their production planning process goes in turmoil impacting production, sales/marketing and other related functions. During high inflation regime, investors tend to disinvest from fixed income securities such as bonds, debentures causing a great upheaval in the market. People tend to spend this money on their other needs fueling further inflationary pressure in the market. Impact on Saving High inflation rate discourages saving thus reducing capital formation necessary for economic growth; on the contrary, high inflationary environment forces people to spend as fast as possible before money loses its value. With increased levels of spending, market gets heated up giving a further upward push to the prices. Overall, market gets hooked up in an inflation trap creating a difficult situation for all. Affects Global competitiveness High-inflation at the domestic front, relative to the trading partner, makes imports lucrative and exports less competitive. This disturbs the trade balances significantly and as a natural consequence, industries involved in exports or competing with imports tend to lose market leading to unemployment in those sectors. Eventually, this can cause its impact on nation's GDP and unemployment rate. No democratically elected government would like to live with this situation for a long time and will resort to the measures necessary to cap the inflation at reasonable levels. Labor Unrest High inflation rate could also be a cause for labor unrest. Union activities increase during high inflation environment because often wages and salaries fail to keep pace with inflation. This disrupts the smooth functioning of the manufacturing units harming productivity and economic growth of the country. Uncertainty The companies from within and outside do not want to invest when instability and uncertainty due to inflation prevails in the country. It has a negative impact on economic growth of the nation. Thus, it becomes quite clear that it is extremely important to control inflation in the larger interest of the economy, people and the country. B) Since the financial/economic crisis, which first manifested itself in 2006/7, the UK rate of inflation has deviated from its bank of England chosen target. Identify these deviations and discuss their possible causes. Answer Source: http://citywire.co.uk/global/central-bank-regime-change-the-new-inflation-rules/a645632#i=1 Bank of England’s targeted inflation rate right from 2007 until date as measured by consumer price index (CPI) has been 2.0 percent. Inflation in terms of CPI, most of the time, has remained above 2.0 percent except for the second half in 2009 when it fell down below the targeted level. But since then it has consistently deviated above ...Download file to see next pagesRead More
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