Define the term budget deficit indicated in bold in the text (paragraph [2]).

Define the term gross domestic product (GDP) indicated in bold in the text (paragraph [3]). 

Using an exchange rate diagram, explain how raising interest rates would “stop the fall in the peso’s value” (paragraph [4]).

Using an AD/AS diagram, explain how the peso’s weakness is “raising inflation” (paragraph [6]).

Note: This question has been amended from the original exam, to remove reference to a second figure that could not be cleared due to copyright restrictions.

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 pesos in USD, USD/peso, USD per peso. The horizontal axis should be quantity, or quantity of pesos. 

A title is not necessary.

A diagram may show demand initially shifting left (and/or supply shifting right) causing the exchange rate to fall and then demand shifting right (or supply shifting left) to restore the value of the peso to its original level. If correctly drawn and explained, this can achieve full marks.

Candidates who incorrectly label diagrams can be awarded a maximum of [3].

For AD/AS the vertical axis may be average (general) price level, or price level. For the horizontal axis, real output, real national output, real income, real national income, real GDP or real Y. Any abbreviations are acceptable. A title is not necessary. “AS” is a valid label for the SRAS curve.

Most candidates scored level 2 on both definitions. A small minority confused budget deficit and current account deficit.

Most candidates scored level 2 on both definitions. A small minority confused budget deficit and current account deficit.

Almost all candidates reached level 2. The diagrams often depicted an increase in demand which was linked to an increase in foreign investment. However, fewer were clear about the type of investment. As higher interest rates typically deter investment in physical capital, it was thus necessary to specify that the higher interest rates would attract financial investment - in the form of savings in Argentinian banks/bonds/financial assets - or lead to increased inflows of "hot money". Some candidates also confused the 'external' supply of the currency with the 'internal' money supply.

This question was also reasonably well attempted. Most candidates could link the weaker currency to a fall in SRAS or at least point to the more expensive imported oil. Some suggested that AD would rise as exports become cheaper and imports more expensive. While theoretically correct, this approach is not aligned to the context set in the referenced paragraph. Paragraph 6 did not suggest any alternative to imported (cost-push) inflation. For all part (b) and (c) questions, it is critical that candidates read carefully the passage of the text referenced.