A-Level Economics May/June 2025 Q1(c): 'In an attempt to bring about disinflation, the Federal Reserve used a contractionary m…

1 answer

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  Disinflation is a fall in the rate of inflation, meaning prices are still rising, but at a slower pace. For example, inflation falling from 5% to 2%. In contrast, deflation is a fall in the general price level, where the rate of inflation is negative. For instance, an inflation rate of -1%.

  Deflation is generally considered more harmful than disinflation. The primary danger of deflation is that it can trigger a deflationary spiral. When consumers and firms expect prices to fall further, they delay purchases and investment. This causes aggregate demand (AD) to fall, leading to lower output, rising unemployment, and a recession. Furthermore, deflation increases the real value of debt, which can lead to widespread defaults and financial instability. This makes it very difficult for monetary policy to stimulate the economy, as even nominal interest rates of 0% may correspond to a high real interest rate.

  While disinflation is often a deliberate policy objective to achieve price stability, the process can have harmful effects. A sharp contractionary monetary policy, as mentioned in the question, raises interest rates, which can reduce investment and consumption, leading to a temporary increase in unemployment and a slowdown in economic growth.

  However, in evaluation, deflation is significantly more pernicious. Its effects, such as the expectation of falling prices and the rising real burden of debt, are self-reinforcing and can trap an economy in a prolonged slump that is very difficult to escape. The negative effects of disinflation are typically a temporary side-effect of a policy aimed at achieving a more stable long-run economic environment, whereas deflation signals a more fundamental weakness in the economy.

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  How the marks are awarded

  • K1 — Awarded for the correct definition of disinflation as 'a fall in the rate of inflation, meaning prices are still rising, but at a slower pace'.
  • K2 — Awarded for the correct definition of deflation as 'a fall in the general price level, where the rate of inflation is negative'.
  • AN2 — Awarded for analysing the problems of deflation, such as consumers delaying purchases, falling aggregate demand, and the creation of a 'deflationary spiral'.
  • EV1 — Awarded for the evaluative conclusion that deflation is 'significantly more pernicious' because its effects are self-reinforcing and harder to escape compared to the 'temporary side-effect' of a disinflationary policy.

  Common mistakes

  • Confusing the definitions of disinflation (a slowing rate of price increases) and deflation (a fall in prices).
  • Describing the terms without comparing their harmfulness, thus failing to answer the 'consider whether' part of the question.
  • Failing to offer an evaluative judgement, which is required to access the final mark.
  • Assuming disinflation is entirely harmless, without considering the potential for higher unemployment or lower growth caused by the contractionary policies used to achieve it.

  Examiner tip: Always define the key terms in the question precisely before developing your analysis and evaluation.

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