Economics · Oct / Nov 2017 · Paper 22 · Question 1

From inflation to deflation For some time, many central banks have tried to achieve a target inflation rate of about 2%. A small and steady rise in the price level can bring a number of benefits to an economy. For central banks and governments, the problem used to be stopping the inflation rate from going above the target rate while keeping the unemployment rate low. Now the problem has changed, and the risk is that inflation will fall below this target rate. At the end of 2014 the consumer prices index in China stood at 100.5. The inflation rate in the country in 2015 was 2%. Meanwhile, a number of countries in Europe experienced deflation. This had several consequences, including increasing the gap between the wages of skilled and unskilled workers. One major reason for the downward pressure on inflation was a fall in the global price of oil from US$120 to US$66 a barrel in 2015. This reduced the price of energy and transport. Lower transport costs had a noticeable impact on the price of food. Fig. 1 shows how the market for food was affected in 2015. S1 price of food S2 P1 P2 D O Q1 Q2 quantity of food Fig. 1 The market for food in 2015 At the same time as falling inflation, some countries experienced falling unemployment. Other countries, however, experienced both falling inflation and rising unemployment. For example, France saw unemployment rising between 2014 and 2015. This put upward pressure on French Government spending.

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