Explain what effect a reduction in interest rates might have on consumption and investment.

Evaluate the effectiveness of using monetary policy to reduce the rate of inflation.

Answers may include:

• definitions of interest rates, consumption and investment
• diagram(s) to show the changes in consumption and investment
• explanation of the impact that a reduction in interest rates might have on consumption and investment
• examples of where reduced interest rates have been introduced and it has affected consumption and investment.

Marks should be allocated according to the Paper 1 markbands for May 2013 forward, part A.

Answers may include:

• definitions of monetary policy, rate of inflation
• diagram(s) to show the impact of monetary policy on AD
• explanation of how monetary policy can be used to reduce inflation by reducing AD by affecting consumption and investment
• examples of where monetary policy has been used to reduce inflation
• synthesis and evaluation.

Evaluation may include: the importance of the type of inflation, the ability to adjust interest rates incrementally and relatively quickly, the significance of time lags, possible conflicts with other objectives of economic policy, such as inflation and growth.

Marks should be allocated according to the Paper 1 markbands for May 2013 forward, part B.