Inflation | Model Answers
A-Level Economics
Evaluate the reasons why the UK government might want to keep the target rate of inflation.
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Definitions
First of all, it might be a good idea to define inflation. 'Inflation can be defined as a sustained rise in the general price level.' In the UK, the inflation target is 2%, as calculated using the CPI.
Why is 2% inflation target a good thing?
Business confidence -> Steady and stable growth of prices gives businesses the confidence to invest. It could attract FDI (foreign direct investment). Why is this? It means that consumers are not afraid to make purchases which leads to higher business profits. Furthermore, because inflation is staying at a steady 2%, it gives businesses more assurance about future prices in the country (which means less risk).
Inflation lessens the standard of living. It increases the cost of living -> too much inflation would deteriorate standards of living.
It is a sign that the economy is growing sustainably. 2% inflation is a sign that the economy is growing at a rate that the growth in productive potential can match.
It helps keep the economy internationally competitive. 2% is a low, steady rate of inflation. If the UK's rate of inflation is below the inflation rate of other countries, then over time the UK will become more competitive.
Inflation lessens the real value of government debt over time.
Reduces risk of deflation.
Why the 2% inflation target might not be right for the economy?
Difficult to manage and policy conflicts -> Use of monetary and fiscal policy to help manage demand-side to achieve the target. The policies aimed at keeping inflation at 2% might conflict with other policies. For example, if the economy is experiencing growth due to increased spending, then the contractionary demand-side policy might be used to slow down this growth for the sake of inflation.
Conclusion
Overall, what do you think about inflation? Should the government aim to keep inflation at a low, steady rate of 2% - use your argument above to conclude.
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