Monday, May 20, 2019

Suggested Solution for 9708/42 March 2019 (CAIE in India)

Section A
(a) Quantitative easing - expansionary monetary policy - Central bank will purchase government bonds/ financial assets from commercial banks - will increase liquidity in banking system - enable banks to generate more lending - supportive of consumption and investment

(b)  Central bank has the responsibility to ensure that the inflation target is met - takes calculated risks every time when they implement QE - slight mistake could be very costly - for instance, if money supply is increased excessively, that may lead to high and unstable inflation - undermines the stability of banking system - people may end up withdrawing money - banks may experience liquidity crisis - unable to accommodate growth

In 2008, banks engaged in sub-prime lending - lent excessively even to people with poor credit history - many defaulted on the loans - banks experienced huge losses being unable to recover most of the loans given out - many were afraid that the banks in the USA and parts of Europe to go bankrupt - withdraw their money - run on the bank - unstable banking system - could cause the economy to collapse if the government did not intervene timely

(c) Fall in the price of oil is due to competitive forces - excess supply in the market - Saudi Arabia over-produced oil - Chinese economic slowdown - fall in the demand for oil for industrial need - collapse in prices

To some extent, the claim is true - oil is a necessity - has low price elasticity of demand - fall in price of oil implies lower export revenue - fall in (X-M) of oil exporting countries - lower AD and hence output and growth

However, the same cannot be said for China - borrowed heavily over the past to fund infrastructure projects - cannot continue to borrow forever - need to scale back spending and start paying back - avoid bankruptcy on banks - fall in G - lower AD and hence output and growth

In conclusion, economic downturn was not just due to fall in oil prices - may be valid for oil producing nations in the OPEC but not for most parts of the world

(d) The article mentions that OECD is concerned that major economies were over-relying on loose monetary policy as a hope for recovery - did not work - historically low level of interest rates - did not stimulate borrowing and spending - consumer and business confidence at all time low - afraid to undertake more commitments - difficulty to pay back

However, the OECD's concern may be unfounded - usually there would be a time lag - flows of information are not perfect - for instance, some may not realise about the rate cut - also firms may have invested in a particular project - unlikely to invest so soon

The extract also mentions that major economies should instead focus on loose fiscal policy - boost government spending onto roads and healthcare - injection into the circular flow of income - rise in AD and hence output and growth - betterment of infrastructure could raise potential capacity of economies - bigger roads reduce congestion - better health will increase productivity at workplace - higher LRAS and therefore potential growth

However, loose fiscal may not work either - China for instance had borrowed heavily in the past - there is a limit to how much more it could borrow further - has to start paying back - same can be said regarding developed economies - have the macroeconomic aim of balanced budget - pursue austerity measures to ensure the goal is met at the expense of growth

In conclusion, it is thought that the global economies will recover - pace of recovery may be different - case to case basis - some countries may experience growth at different level

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