Economics (AS & A Level) · Oct / Nov 2021 · Paper 21 · Question 1

What is the ‘right’ level of inflation? Central banks aim to keep inflation under control, but what does ‘under control’ mean? How much inflation is too much? And, a question only an economist could ask, how much inflation is too little? Hyperinflation, where the rate of inflation is extremely high, is an economic catastrophe for a country. Table 1.1 below gives details of four cases of hyperinflation. Table 1.1 Country Date Highest monthly inflation rate (%) Time taken for prices to double (hours) Hungary 1945 to 1946 41900000000000000 15 Zimbabwe 2007 to 2008 79600000000 25 Germany 1922 to 1923 29500 89 Venezuela 2016 to 2018 219 430 Source: www.cato.org/research/world-inflation-and-hyperinflation-table, accessed October 2019 The consequences of hyperinflation are far-reaching. Inflation undermines the functions of money. Rapid price rises encourage panic-buying by consumers, creating shortages that further increase inflation. In the most extreme cases countries stop using money completely, and resort to barter. In Zimbabwe, hyperinflation led to the abandonment of its currency in 2008 and the use of the US dollar as an alternative. More recently, Venezuelan restaurants and supermarkets stopped displaying prices and consumers only found out the value of their purchases at the checkout. To avoid the consequences of high inflation, central banks often set a low ‘target’ rate of inflation, typically around 2% a year. But this policy has also been criticised by some people. If central banks follow such a target the outcome would be to erode the real value of money over time. Central banks have often been instructed by governments to have an inflation target, and yet even a 2% inflation rate will halve the real value of money in 36 years. Central banks can use high interest rates as a tool of monetary policy to keep down the rate of inflation, but very often monetary policy requires low interest rates to stimulate consumption spending and investment in an economy. It should not be forgotten that there are potential benefits of relatively low levels of inflation and this is why some countries have an inflation target of, say, 2%. A former chief economist of the International Monetary Fund even suggested that many countries’ inflation target should be 4% rather than 2%. Source: Adapted from The Times and The Financial Times, both 9 February 2019.

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