Economics

Extra Notes (for Mrs Long's tutorial class)

Introduction:

• State that whether Fed's action to raise interest rates to curb inflation will succeed depends on the causes of inflation and the responsiveness of C and I to the higher interest rates.

Body:

[Demand-pull inflation]

• Explain how increases in interest rates can reduce C and I and thus lower demand-pull inflation
  
• Examine the effectiveness of such a policy by considering:  

1. Slope of the LP curve and the interest elasticity of C and MEI
2. Relative significance of the other determinants of C such as income, expectations of consumers etc and other determinants of I such as business sentiments
3. Depending on the k effect - US MPC is high so k should be large

• Suggest the use of contractionary fiscal policies advocated by Keynesians

[Cost-push inflation]

• If the inflation is the cost-push type, increase in interest rates would be ineffective in controlling inflation.
• Briefly mention the types of cost-push inflation (wage-push, profit-push and import-price-push.)
• Suggest methods of tackling cost-push inflation such as reducing the power of the trade unions, increase labour productivity, introducing wage ceiling, reducing dependence on imported goods & raw materials by looking for cheaper substitutes or appreciating the exchange rate (not likely), and regulating the monopolies.