Analyzing Inflation and Deflation in Global Economies
1(a) Japan: Sales Tax and Inflation
a) Which one of the following is most likely to explain the data? (1 mark)
Answer: C
C. In April 2014, Japan raised its sales tax from 5% to 8%.
The graph shows inflation rising sharply during 2014 before falling again. A higher sales tax directly increases consumer prices, causing a temporary increase in CPI inflation.
1(b) Defining Deflation in Japan
(b) With reference to Figure 6, explain the term deflation. (4 marks)
Deflation is a sustained fall in the general price level, meaning the inflation rate becomes negative. Consumers and businesses experience falling average prices over time.
Figure 6 shows Japan experienced brief periods of deflation, for example, around 2011–2013 and again during 2016, when the inflation rate fell below 0%. This means prices were falling rather than rising. Deflation is different from disinflation because prices are actually decreasing rather than simply rising more slowly.
2(a) Disinflation in Emerging Markets
2(a) With reference to the information above, explain the term disinflation. (4 marks)
Disinflation is a fall in the rate of inflation, meaning prices continue to rise but at a slower rate than before.
The extract states that inflation across emerging markets fell from 20% in 1996 to a record low of 2.5% in July 2017. Prices were still increasing, but the rate of increase had slowed significantly. This is disinflation rather than deflation because inflation remained positive.
3(a) Singapore: Aggregate Demand and Inflation
3(a) With reference to the extract, examine the likely impact on Singapore’s inflation rate of the expected rise in aggregate demand in 2017. (8 marks)
(Note: Refer to a short-run AD/AS diagram showing AD shifting right.)
An increase in aggregate demand (AD) will tend to increase both the price level and real GDP. As households, firms, and the government spend more, demand for goods and services rises. This creates demand-pull inflation.
The extract states that Singapore expected stronger economic growth in 2017 than in 2016, with GDP growth increasing from 2% to between 2% and 3%. This suggests aggregate demand was expected to rise, shifting the AD curve to the right. Firms respond by increasing output and employing more workers, while higher demand puts upward pressure on prices.
However, the extract also states that demand-pull inflationary pressures were expected to remain weak because there was excess supply in the labour market. Since unemployment was above full employment, firms could expand production without facing severe labour shortages or rapidly increasing wages. Therefore, inflation would probably rise only slightly.
The extract further explains that any increase in inflation would occur after a time lag. Businesses may initially meet higher demand using spare capacity before raising prices, delaying any increase in inflation.
Overall, inflation was likely to increase only modestly. The existence of spare capacity and weak wage growth would limit demand-pull inflation. Only if aggregate demand continued to grow over a longer period and the economy approached full employment would inflationary pressures become much stronger.
4(a) Zimbabwe: Currency and Imported Deflation
4(a) Explain the likely impact on Zimbabwe’s inflation rate of the fall in the value of the South African Rand (ZAR) against the US Dollar. (4 marks)
Zimbabwe adopted the US Dollar as its main currency in 2009. The extract explains that many imported goods come from South Africa.
When the South African Rand fell against the US Dollar, South African exports became cheaper for Zimbabwe. Lower import prices reduced firms’ production costs and lowered the prices consumers paid for imported goods.
This created imported deflation, helping Zimbabwe’s consumer prices fall by between 2% and 4% in 2015, as stated in the extract.
4(b) Economic Impacts of Deflation in Zimbabwe
(b) With reference to the extract and Figure 7, examine the likely impact of deflation on Zimbabwe’s economy. (8 marks)
(Note: Refer to an AD/AS diagram showing AD shifting left.)
Deflation is likely to reduce economic activity because consumers and firms delay spending, expecting prices to fall further. Lower spending reduces aggregate demand, causing firms to cut production.
The extract warns that Zimbabwe could enter a cycle of shrinking demand and falling production. As firms receive less revenue, they reduce output and investment, causing national income to fall. This weakens the circular flow of income, as households receive lower wages and spend less, further reducing aggregate demand.
Figure 7 shows that although Zimbabwe experienced strong GDP growth between 2009 and 2012, growth slowed considerably after 2013. Continued deflation could reduce growth even further.
Lower production is also likely to increase unemployment. The extract states that businesses may be forced to lay off workers or stop paying wages because of cash shortages. Higher unemployment reduces household income, causing consumption to fall further and reinforcing deflation.
Government finances may also deteriorate. With weaker economic activity, tax revenues fall, yet the extract explains that around 90% of government revenue is already spent on wages, limiting its ability to increase spending and stimulate demand.
However, deflation following Zimbabwe’s period of hyperinflation is not entirely negative. Lower prices increase consumers’ purchasing power and restore confidence in the currency. Imported goods become more affordable, benefiting households.
Furthermore, this period of deflation is unlikely to be as damaging as the previous hyperinflation. Hyperinflation destroyed confidence in the currency and disrupted the economy, whereas moderate deflation caused by lower import prices may simply help stabilise prices. If the government restores confidence and encourages investment, the economy could recover, although this may take time.
5(a) Turkey: Causes of Rising Inflation
5(a) With reference to the extract and Figure 8, analyse one cause of rising inflation in Turkey over this period. (6 marks)
(Note: Refer to a short-run AD/AS diagram showing SRAS shifting left.)
One major cause of rising inflation was cost-push inflation resulting from the depreciation of the Turkish Lira and rising energy prices.
When the Turkish Lira fell in value, imported raw materials and energy became more expensive because Turkey had to pay more Lira for each US Dollar of imports. At the same time, rising global energy prices increased firms’ production costs.
Higher production costs shifted the short-run aggregate supply (SRAS) curve to the left. As firms faced higher costs, they reduced output and increased prices, causing inflation to rise while real output fell.
The extract states that Turkey experienced both a sharply falling Lira and rising energy prices. Figure 8 shows inflation increasing from approximately 9% in January 2017 to around 12% by April 2017, supporting the argument that production costs were driving inflation.
This represents cost-push inflation, rather than demand-pull inflation, because prices rose as a result of increasing production costs rather than excessive aggregate demand.