Hard question from Trial (1 Viewer)

[rsingh]

"Explain the links between inflation, the current account balance, and economic growth." [5 marks].

This question in our trials stumped most of the students at our school! Any ideas?

 

[nick1048]

inflation leads to a deterioration of the current account deficit on the current account as prices rise making imports cheaper and costs of productions rise (for instance the cost of labour in "cost-push" inflation) which will be passed onto consumers in the form of higher prices. This leads to a deterioration in the terms of trade as domestic commodities are now harder to export relative to other nations incurring non-inflationary pressures. This deterioration or decline in the terms of trade would upset the current account balance and increase the economies CAD.

In terms of economic growth, high inflation acts as a curb against economic growth due to a few factors. Consider the effects of high inflation on an economy, in Australia monetary policy is used to curb inflationary pressures in the form of interest rates manipulated by the RBA's control over the cash rate. With high inflation rates, interest rates would be forced to rise making it more difficult for industries to access funds and force relluctant loan taking decisions from such industries. This would result in a retarding or slowing down of the growth of a firms productive capacity and hence reduce economic growth in terms of an entire economy. There are other reasons however this should be enough to achieve 5 marks, hope it helps

 

[Rafy]

=/ did your school set your paper?

(I got that exact same question yesterday.......and yes i did see this thread before the exam)

 

[~ ReNcH ~]

And in addition to what Nick1048 said, high levels of economic growth tend to lead to demand-pull inflation as consumers have higher disposable incomes etc. Essentially, in summary:

1. High levels of economic growth --> Inflation --> Decreased international competitiveness --> Deterioration of the Balance on Trade --> Increased CAD

2. Inflation --> RBA increasing interest rates --> Decreased growth. To a lesser extent, an increase in interest rates may also encourage greater investment from overseas which will further deteriorate the CAD due to a higher level of foreign liabilities.

The best way to represent this is really with a flow chart. The good thing about economics is that it is purely hypothetical...anything can happen as long as you justify yourself...one change in the economy can have numerous repercussions. What's more these repercussions may even contradict each other, but it depends on the state of the economy at the time.

 

[sunjet]

Talk about phillps curve

 

[~ ReNcH ~]

Talk about phillps curve

You'd have to make a link between economic growth and unemployment first though.

 

[sunjet]

High growth -> less cyclical unemployment -> more income -> bracket creep -> greater bargaining power -> cost-push inflation also greater demand (demand-pull) and vice-versa

 

[Conspirocy]

"Explain the links between inflation, the current account balance, and economic growth." [5 marks].

This question in our trials stumped most of the students at our school! Any ideas?

all i have to say is if i got that for my trials or my hsc i would have written 3 extended responses cause that question is either really badly worded because im sure they had a specific answer in mind, or really unfair.

i wouldnt go with that phillips curve though
- id look at inflation and its affect on components of the current account balance and then how the current account balance determines to an gdp which is a measure of economic growth

- so basically inflation influences input costs for australian exports and therefore reduces their international competativeness which could lead to australian exports being bought less so then our current account balance gets a bit stuffed
- then you could go yeah trade is one of the strongest growing areas of economic growth, the balance of goods and services a compenent of the CAB is a measure of this contributor to economic growth and so thats how they link
- but to get five marks gee thats hard, maybe talk about what would happen to imports as real incomes decline due to inflation (that is you can buy less with the same amount of money assuming no changes in the wage rate) so there is less money to spend on imports and so they also decline, which would be a positive thing for the CAB (although you could say the terms of trade, and substution for imports because they are cheaper...didnt think of that good one p.s. i put the bracketd part in after)
-still i dont think i would get 5 marks for this like to do it properly u would have to sit there and go into a lot of depth
- id probably leave that till the end of the exam

actually after reading the other answers i think mine is better because:
- you go off topic, e.g unemployment
- and yeah not actually linking them

 

[Conspirocy]

sorry, me again, this question is really bugging me

okay i think there is a certain way to answer this question
- first of all you have to answer it in this order: inflation--> current account balance -->economic growth (and i do know that im assuming inflation has taken place, but i think that is fair enough)
- second, people keep adding information to their answers to make it easier. Like making assumption --> so the government always raises interest rates to respond to inflation (ummm who said the government responded), oh and yeah unemployment is low in times inflation ( um well this is being a smartass but like stagflation) i really really think that you cant talk about interest rates and unemployment in this question for 5 marks, if its an essay and its like discuss the links then you can make all the assumption you want and look at cause and effect. but it says explain

what else didnt i like
yeah i'll pay the inflation curbs growth --> how did you link that with the current account balance again? oh wait you didnt, maybe u implied it...

now im not sure about this one but ill still point out
- does anyone think that high levels of economic growth lead to inflation?? what are u using to measure ur economic growth?

and dont even get me bracket creep, cyclical unemployment, phillips curve etc i just think that is plain wrong

now please not that this is my oppinion and you could possibly answer this question how other people have said and get 5. i personally dont see how, but im not going to say im looking at this the perfect way (even though i kinda think im looking at it more reasonably) but i could be way off and just not viewing it like how everyone else on this thread has. like you would get marks for everything people have said, i just think u might have to start combining peoples answers

 

[~ ReNcH ~]

There are really many ways to approach the question, simply because there are so many links between the three issues. You could bring in the Phillips Curve if you wished to - economic growth --> low unemployment --> high inflation (according to the Phillips Curve). That said, economic growth causes inflation in its own right due to demand-pull inflation.

 

[sunjet]

Well, in my opinion with economics there are so many asnwers to a question (Short Answer) as nothing really goes unchanged without affecting something else in the economy.

 

[rsingh]

Sorry guys for the late reply.
Well I haven't got my trial back yet, but this question is a little bit nasty.

So what would be a concise, to the pt answer for 5 marks?
I can see that so many people have made different pts, just which one would go?

 

[~ ReNcH ~]

Sorry guys for the late reply.
Well I haven't got my trial back yet, but this question is a little bit nasty.

So what would be a concise, to the pt answer for 5 marks?
I can see that so many people have made different pts, just which one would go?

Afaik, everything that was said is correct. The best, most succinct response is really the one you understand most. Go through the answers given on this thread and write down the different relationships as a flow chart - that will help you visualise what's happening. Once you've done that, try coming up with your own concise 5 mark response to the question and post it on this thread or show your teacher. The guys on here will be happy to give you feedback. It's much better than us giving you the answer. Writing it up yourself is the best way to remember it.

 

[Demandred]

Well I guess whenever you encounter a question with the word 'effects' think of the the circular flow of income.