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Comparing High Inflation and Current Account Deficit

Question

Discuss whether a high rate of inflation or a deficit on the current account of the balance of payments is the more serious problem for an economy. [12]

Category:

Macroeconomic Factors and Policies

[CIE AS May 2018]

Preview Answer


Step ➊ : Define ‘inflation’ and ‘a current account deficit’ in the introduction.


A high rate of inflation and a current account deficit can both have major impacts on the economy. Inflation is a sustained increase in the general price level of goods and services in an economy over a period of time. A current deficit is when a country imports more goods, services, and capital than it exports. Several factors should be considered before concluding which is a more serious problem to the economy.


Step ➋ : Discuss whether a high rate of inflation is a serious problem for an economy. Discuss the ways inflation can be harmful and why it is not always harmful.


➤ 2.1 Inflation may be harmful to an economy in several ways

⫸ 2.1.1 A relatively high inflation may reduce the international competitiveness of a country’s products and so increase import expenditure and lower export revenue. This may result in a deficit on the current account of the balance of payments.


⫸ 2.1.2 Inflation will typically make borrowers better off and lenders worse off.

For instance, if the rate of interest does not rise in line with inflation, borrowers will gain and lenders (savers) will lose. This is because borrowers will pay back less in real terms and lenders will receive less.

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