Apr 2017 Paper 1 Qn5

Discussion in 'CA1' started by Clint Tan, Apr 14, 2018.

  1. Clint Tan

    Clint Tan Member

    Hi,

    I am abit confused of the answer to this question:
    "A highly developed economy has been in recession for a number of years, with interest rates and inflation at historically low levels.
    The central bank has warned that interest rates will rise in the short term.
    1 (i) Outline two reasons why the central bank is intending to increase rates."

    Part of the answer is:
    "The government may want to control inflation
    Higher real interest rates mean a decreased quantity of money is demanded which is met by a decrease in the money supply. This can lead to reduced inflation. Higher real interest rates can assist in any inflationary pressures by decreasing demand in the real economy. "

    It says higher interest rate leading to reduced inflation... But the economy is already experiencing low inflation and interest rate. Why would we want to increase interest rates to reduce inflation? And in the first place, does low interest rate and low inflation goes together?

    Hope someone could help me with this!

    Thanks!:)
     

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