| Date | November 2016 | Marks available | 4 | Reference code | 16N.2.SL.TZ0.1 |
| Level | Standard level | Paper | Paper 2 | Time zone | Time zone 0 |
| Command term | Explain | Question number | 1 | Adapted from | N/A |
Question
New Zealand dollar overvalued
- The New Zealand finance minister said the exchange rate of the New Zealand dollar (NZD), is “unsustainably high; it is somewhere between 10 % to 15 % overvalued”.
- The NZD had been near its record high against the US dollar before weakening last week on slower inflation figures and a fall in dairy prices. The NZD has gained about 6 % so far this year.
- However, the finance minister said that New Zealand exporters had developed strength because of the high currency. “New Zealand is actually in reasonably good shape,” he said. “We have had an export sector operating with a strong exchange rate now for five or six years and that has had an impact on efficiency.”
- An economist said recently that the central bank might consider intervening in the currency market to achieve a depreciation in the value of the NZD.
- The Reserve Bank (central bank) governor raised the official interest rate for the fourth time this year to 3.5 % at a time when other major economies have their rates at record low levels.
- He said that, “Encouragingly, the economy appears to be adjusting to the monetary policy tightening that has taken place since the start of the year. It is important that inflation expectations remain contained. This interest rate increase will help keep future average inflation near the 2 % target and ensure that the economic expansion can be sustained”.
- New Zealand’s economy is expected to grow at an annual pace of 3.7 % over 2014. New Zealand government figures showed a monthly trade (in goods) surplus of $247 million in June 2014 compared to $371 million in June 2013. The annual trade (in goods) balance turned to a surplus of $1.2 billion from a deficit of $819 million a year earlier.
- Global demand for New Zealand dairy products has been a key support for the country’s exports over the past 18 months, though prices have dropped this year with increased supply.
Define the term depreciation indicated in bold in the text (paragraph [4]).
Define the term monetary policy indicated in bold in the text (paragraph [6]).
Using an exchange rate diagram, explain how the increase in the official interest rate to 3.5 % is likely to affect the value of the New Zealand dollar (paragraph [5]).
Using an AD/AS diagram, explain how “monetary policy tightening” may affect a country’s inflation rate (paragraph [6]).
Using information from the text/data and your knowledge of economics, discuss the possible economic consequences of an overvalued New Zealand dollar on the New Zealand economy.
Markscheme
Level
0 The work does not reach a standard described by the descriptors below. [0]
1 Vague definition. [1]
The idea that the exchange rate/value (price) of a currency falls.
2 Accurate definition. [2]
An explanation that it is a decrease in the value (price/exchange rate) of one currency plus one of the following:
- due to a change in market forces
- in a floating exchange rate system.
Level
0 The work does not reach a standard described by the descriptors below. [0]
1 Vague definition. [1]
The idea that is to do with interest rates (or money supply).
2 Accurate definition. [2]
An explanation that it is any two of the following:
- demand-side policy
- changes in interest rates
- changes in money supply.
Level
0 The work does not reach a standard described by the descriptors below. [0]
1 There is a correct diagram or an accurate written response. [1–2]
For drawing a correctly labelled exchange rate diagram, showing a shift of the demand curve for the New Zealand dollar to the right or for an explanation that when the interest rate rises, people abroad will wish to save more in New Zealand financial institutions, and so demand for the currency will increase and the value of the currency will rise (appreciate).
2 There is a correct diagram and an accurate written response. [3–4]
For drawing a correctly labelled exchange rate diagram, showing a shift of the demand curve for the New Zealand dollar to the right and for an explanation that when the interest rate rises, people abroad will wish to save more in New Zealand financial institutions, and so demand for the currency will increase and the value of the currency will rise (appreciate).
Candidates may offer an alternative explanation that, because of the interest rate increase, there might be an increase of “hot money” inflows, leading to the shift in the demand curve. This may be fully rewarded.
Candidates who incorrectly label diagrams can be awarded a maximum of [3].
For an exchange rate diagram, the vertical axis may be exchange rate, price of NZD in other currencies, or other currency per NZD. The horizontal axis should be quantity or quantity of NZD. A title is not necessary.
Level
0 The work does not reach a standard described by the descriptors below. [0]
1 There is a correct diagram or an accurate written response. [1–2]
For drawing a correctly labelled AD/AS diagram, showing a shift of the AD curve to the left or for an explanation that monetary policy tightening (increasing interest rates and/or reducing the money supply) should reduce consumption and/or investment, components of AD (C+I+G+[X−M]), lowering the inflation rate (inflationary pressure) in the economy.
2 There is a correct diagram and an accurate written response. [3–4]
For drawing a correctly labelled AD/AS diagram, showing a shift of the AD curve to the left and for an explanation that monetary policy tightening (increasing interest rates and/or reducing the money supply) should reduce consumption and/or investment, components of AD (C+I+G+[X−M]), lowering the inflation rate (inflationary pressure) in the economy.
Candidates who incorrectly label diagrams can be awarded a maximum of [3].
For AD/AS, the vertical axis, the label may be Average (General) Price Level, APL or Price level. For the horizontal axis, real output, real national output, real income, real national income, real GDP or real Y. A title is not necessary.
Examiners should be aware that candidates may take a different approach which, if appropriate, should be rewarded.
Do not award beyond Level 2 if the answer does not contain reference to the information provided.
Level
0 The work does not reach a standard described by the descriptors below. [0]
1 Few relevant concepts are recognized. [1–2]
There is basic knowledge/understanding.
2 Relevant concepts are recognized and developed in reasonable depth. [3–5]
There is clear knowledge/understanding.
There is some attempt at application/analysis.
3 Relevant concepts are recognized and developed in reasonable depth. [6–8]
There is clear knowledge/understanding.
There is effective application/analysis.
There is synthesis/evaluation, supported by appropriate theory and evidence.
Command term
Discuss requires candidates to offer a considered and balanced review that includes a range of arguments, factors, or hypotheses. Opinions or conclusions should be presented clearly and supported by appropriate evidence.
Responses may include:
Inflation rate:
- the current inflation rate seems to be reasonable near 2% target (paragraph [6])
- a strong dollar will lower the cost of imported raw materials, semi-finished goods, and finished goods, reducing inflationary pressure.
Employment:
- in the short run, export prices will rise and import prices will fall, leading to reduced employment in both export industries, as demand for exports falls, and domestic industries, as people buy more imports
- the export sector is used to high exchange rates and remains competitive, so employment rates may not be as badly affected in export industries (paragraph [3]).
Economic growth:
- the expected growth rate is 3.7% (paragraph [7]) – reasonably high for a developed country
- a fall in net exports would lead to lower AD and so a fall in growth rates
- firms are efficient and competitive (paragraph [3]), so economic growth may not be so badly affected
- possible intervention by the central bank to depreciate the currency (paragraph [4]) to prevent net exports from decreasing and slowing economic growth.
Current account balance:
- a high exchange rate could lead to a fall in net exports and so a movement towards a current account deficit
- exporters seem to be coping with a high exchange rate (paragraph [3]) and so net exports may not be affected greatly on the export side
- the effect may be greater on the import side
- there is a present trade in goods balance surplus of $1.2 billion (paragraph [7])
- overvalued NZD may begin to harm New Zealand dairy products which is a key export (paragraph [8]).
Any reasonable discussion.
Examiners report
The majority of candidates found this to be a straightforward question. Lower achieving responses explained that it was a decrease in the value of one currency, but omitted to explain that it was in a floating exchange rate system, or due to changes in market forces. The lowest achieving responses confused the term with deflation and thought that it was falling prices in the economy.
The majority of candidates were able to explain that it is a demand-side policy, relating to changes in interest rates (or changes in the money supply). Lower achieving responses confused monetary and fiscal policies.
The majority of candidates drew an exchange rate diagram, with a shift of the demand curve for the New Zealand dollar to the right and an increase in the exchange rate. They then explained that people abroad would want to take advantage of the higher interest rate by saving in New Zealand financial institutions, increasing demand for the currency and so increasing its value. Others wrote about ‘hot money’ inflows and were also fully rewarded. Lower achieving candidates clearly did not understand the question and provided all sorts of incorrect diagrams, many not related to exchange rates.
This was generally a well answered question. The majority of candidates provided an AD/AS diagram, with a shift of the AD curve to the left, and a fall in the average price level. They then explained that monetary policy tightening, increasing interest rates, should reduce components of AD, such as consumption and/or investment, lowering inflationary pressure in New Zealand. Lower achieving candidates were not aware that monetary policy related to interest rates (and money supply), and so were unable to provide a relevant diagram or explanation.
“Discuss” requires candidates to offer a considered and balanced review that includes a range of arguments, factors or hypotheses. Opinions or conclusions should be presented clearly and supported by appropriate evidence.
Higher achieving responses explained the meaning of an overvalued currency and then went on to consider the consequences of the high exchange rate for different macroeconomic indicators, such as the inflation rate, employment, economic growth, and the current account balance. They used information from the text to support their opinions. They discussed the possible outcomes and reached a considered conclusion regarding the overall impact. Lower achieving responses ignored the text and were very vague about the consequences of an overvalued currency. Some persisted with the idea that an overvalued New Zealand dollar was another way of saying that there was inflation in the economy.
