AQA Macro: Remember to revise inflation

The AQA Unit 2 macro paper is normally fairly standard - they have to examine key topics and the ideas of macro performance and macro stability are nearly always near the top of the agenda. That said the issue of inflation has not been a main focus on the data response paper for a little while now and ought to be a crucial component of last minute revision - here is why

For the last sixteen months the rate of inflation in the UK economy has been well above the 2% target set for the Bank of England by the government. Governor Mervyn King has had to pen over ten letters to the Chancellor explaining the causes of the inflation over-shoot. To put things into context, we are not talking about the double-digit inflation rates experienced during the 1970s and 1980s. Inflation of 4% is low by those standard but for a new generation of young economists it seems quite a high number! Context is important in deepening your evaluation!

In revision I would make sure that you are clear about all of the following:

1/ The measurement of inflation (i.e. consumer price index and retail price index) and the difference between the price level and the rate of change of prices

2/ The underlying causes of inflation - namely demand-pull and cost-push factors and their relative significance in the near and longer-term. Why is inflation high even though we are just emerging out of a deep recession? This suggests that cost-push factors have been more important and especially the inflationary impulses from outside of the UK economy. This leads onto point 3

3/ Understand how external forces / shocks can affect the rate of inflation in the UK .... for example:

i) A depreciation of the exchange rate affecting the sterling price of imported products (given the exam was set last year, the depreciation of sterling in 2008-09 might well be a focus of the data)
ii) Higher inflation in some of our trading partners (notably China and India and many other fast-growing emerging economies)
iii) The effect of strong increases in global food, energy and raw material prices

4/ Make sure you can use AD-AS analysis as a strong foundation for your explanations - e.g. the impact of rising production costs on the SRAS curve

5/ The emphasis then switches to the effects of rising inflation ... linking to other macroeconomic objectives

i) Inflation and real incomes of consumers
ii) Relative inflation rates and the international competitiveness of our business sector
iii) The debate at the Bank of England about whether to use higher interest rates as the main tool to bring inflation back into target range - the effects of higher base rates if it did so
iv) Higher inflation and business confidence / uncertainty

6/ Evaluation questions might ask you to consider which policies are likely to be most effective in controlling inflation. The AQA examiners seem to be very keen on the role of supply-side policies as a way of combating possible conflicts between different macro objectives. So please ensure that you understand how supply-side policies can impact on LRAS and provide the basis for stronger growth and rising employment without causing inflationary pressures. Fiscal and monetary policies and their effects on prices should be revised carefully. A critical evaluation of all three approaches is needed - not least if you are discussing how best to maintain price stability over the medium term.

I have linked below to some of our recent blog posts and revision notes on the inflation issue. This is one topic that you cannot ignore in the days ahead!