Jun 09 - Unit 4

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Paper Reference(s)

6356/01EdexcelGCEEconomicsAdvancedUnit 6 – The UK in the Global Economy(Synoptic Unit)Friday 12 June 2009 – MorningTime: 1 hour 45 minutes

Materialsrequiredforexamination ItemsincludedwithquestionpapersNil Nil

InstructionstoCandidatesIn the boxes above, write your centre number, candidate number, your surname, initial(s) and signature. Check that you have the correct question paper.Write your answers in the spaces provided in this question paper.Answer ONE Question from Section A and ONE Question from Section B.Indicate which question you are answering by marking the box ( ). If you change your mind, put a line through the box ( ) and then indicate your new question with a cross ( ).

InformationforCandidatesThis question paper is designed to give you the opportunity to use the skills and ideas developed throughout the course in a new context. You may include in your answers relevant information from the whole of your course, where appropriate.There are 28 pages in this question paper. Any blank pages are indicated.The marks for the various parts of questions are shown in round brackets: e.g. (2).Questions in Section A will be marked out of 100; those in Section B will be marked out of 50. The mark out of 100 for Section A will be divided by two and added to the mark out of 50 on the chosen question from Section B.

AdvicetoCandidatesYou are advised to divide your time equally between Section A and Section B. You will be assessed on your ability to organise and present information, ideas, descriptions and arguments clearly and logically, including your use of grammar, punctuation and spelling.

Paper Reference

6 3 5 6 0 1

This publication may be reproduced only in accordance with Edexcel Limited copyright policy. ©2009 Edexcel Limited.

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SECTIONA

AnswerONEquestionfromthissection.

Youshouldspendapproximately45minutesonthissection.

Youmayincludediagram(s)inyouranswerswherethesearehelpful.

1. (a) Examine the effect of a substantial fall in UK house prices on the UK economy. (40)

(b) Assess the effectiveness of further supply side policies in preventing a recession in the UK.

(60) Q1

(Total100marks)

2. (a) Thevalueofthepoundfellfrom£1=€1.47inMay2007to£1=€1.18inNovember2008. Examine the factors which might explain this depreciation of sterling against the euro.

(40)

(b) Evaluate the likely effects on the UK economy of the decrease in price of oil from $147 per barrel in July 2008 to $56 per barrel in November 2008.

(60) Q2

(Total100marks)

3. The UK government forecasts that by 2028 a quarter of the adult population will be aged over 65. In addition, it is estimated that there was an annual average net migration into the UK of 189 000 between 2000 and 2006.

(a) Discuss the impact of an ageing population on the UK’s public finances andinternational competitiveness.

(40)

(b) Evaluate the economic effects of an increase in net migration on the UK economy.(60) Q3

(Total100marks)

TOTALFORSECTIONA:100MARKS

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PutacrossintheboxindicatingthequestionfromSectionAthatyouhavechosen( ).Ifyouchangeyourmind,putalinethroughthebox( )andthenindicateyournew

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SECTIONB–DATARESPONSE

AnswerONEquestionfromthissection.

Youshouldspendapproximately45minutesonthissection.

IfyouanswerQuestion4putacrossinthisbox.

Question4 UKimbalancesandtheglobalrecession

Figure1:UKSavingsRatioandHouseholdDebt

1988 90 92 94 96 98 2000 02 04 06

%160

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Extract1 Attemptstopreventaglobaldownturn

The US economy is either in or very close to recession and other rich countries’ economies are weakening as the credit crunch tightens. The credit crunch led to an unwillingness of banks to lend money to businesses and consumers. In its new forecast, the International Monetary Fund expects global growth to slow from 4.9% last year to 4.1%: rich countries will manage only 1.8%, but that could prove to be optimistic. Since the slowdown came from a financial collapse, the outlook is particularly uncertain.

Confidence in using government tax and spending decisions as the prime tool for smoothing the economic cycle in the 1960s and 1970s was shattered by stagflation and rising budget deficits. However, in the US politicians have used expansionary monetary and fiscal policy to boost the economy. The Federal Reserve (the US central bank) has cut short-term interest rates by 1.25% in recent weeks to 3% (with further cuts to 2% by April 2008). In February 2008, George Bush signed into law a package of tax rebates and temporary investment incentives worth $153 billion or just over 1% of GDP. The reason for all this activity by policymakers is the short-term need to respond to the downturn: employment is falling, consumers spending is growing very slowly and credit conditions are tightening. Also the Federal Reserve and the US Treasury believe that by giving a stimulus now, they will minimise the risk of a nasty financial crisis and deep recession.

This logic is now being echoed by the International Monetary Fund which is urging other countries to draw up their own fiscal plans in case the outlook for the global economy worsens. Monetary policy may be ineffective in this downturn, argues the Fund’s managing director, Dominique Strauss-Kahn. The European Central Bank has refused to reduce interest rates, largely because of concerns over inflation. It has also criticised the idea of a fiscal stimulus, fearing that it will do more harm than good. By the time that the tax cuts and government spending increases arrive, the downturn is often over, and the extra stimulus simply increases inflationary pressure. Further, European countries have more automatic stabilisers than the United States so such a fiscal stimulus is seen as unnecessary.

Others argue that a temporary stimulus, even if well-timed, will not work because people will hardly adjust their spending in response to a one-off tax cut. Another problem is that countries such as Britain and the US have underlying budget deficits of 3.1% and 3% of GDP respectively, giving them little room to provide a fiscal stimulus. On the other hand, many of the world’s rich economies have long-term fiscal surpluses. In 2007, almost half of the countries within the OECD ran structural fiscal surpluses (that is, adjusted for the business cycle).

Adapted from The Economist 16 February 2008

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(a) With reference to Figure 1, explain the factors which might account for the trends in the savings ratio and household debt between1997and2007.

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(b) Examine the significance of the data in Figure 1 for explaining the trend in the current account of the Balance of payments as shown in Figure 2 between1997and2007.

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(c) Apartfromthebalanceofpayments, assess two other likely implications for the UK economy of the trends in the savings ratio and household debt since1997.

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(d) With reference to Extract 1, evaluate the likely economic effects of a slowdown in the US economy on the UK’s economy.

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(e) (i) Explain what is meant by �budget deficits’ (Extract 1, line 30)(e) (i) Explain what is meant by �budget deficits’ (Extract 1, line 30)

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(e) (ii) Assess the case for using a �fiscal stimulus’ (Extract 1, line 31) to prevent a(e) (ii) Assess the case for using a �fiscal stimulus’ (Extract 1, line 31) to prevent a recession in the UK or the US.

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Question5 TheExchangerateandtheBalanceofPayments

Extract1 Thevalueofsterling

In November 1967, Britain woke up to the fact that the pound had been devalued. After three years of trying to maintain sterling’s exchange rate at $2.80 against the American dollar, Harold Wilson (the Prime Minister) threw in the towel and set a new fixed exchange rate of $2.40. A cheaper pound was needed by Britain in the late 1960s because it choked off imports and made exports cheaper. It took three years to turn the trade figures round but by 1970 a deficit of just under £470 million had been turned into a surplus of a similar size. Devaluation not only means political trouble – it often leads to higher inflation.

Is this strictly relevant to where Britain is today? On the one hand it is not relevant because under a floating exchange rate the pound cannot, strictly speaking, be devalued. It can depreciate but the decline does far less damage than admitting that the defence of a fixed rate has been in vain. However, there are two reasons why the economic crisis of the late 1960s is relevant. The first reason is there is a need for a significant reduction in the value of the pound to rebalance the economy. The second is that the governor of the Bank of England seems to be doing his best to engineer one.

What is supposed to happen under floating exchange rates is that the currency adjusts to ensure that the current account of the balance of payments stays broadly in balance. In practice, though, currencies have a tendency to overshoot and become either too cheap – leading to huge current account surpluses – or too overvalued, leading to massive deficits. A measure of the over-valuation of the pound is that Britain’s trade in goods deficit is now running at £90 billion a year, and more than £50 billion once the proceeds from services are taken into account.

The current account deficit is not only caused by de-industrialisation and lower production from Britain’s North Sea oil fields since 1997 but also by the growing deficit on the travel and tourism account.

Today, the fact the trade in goods deficit is careering towards £100 billion a year seems to concern only a handful of policymakers. One of them is the governor of the Bank of England who said that a 40 per cent drop in the dollar’s trade-weighted index over the last five years had led to a sharp rise in net US exports. A similar rebalancing of the British economy was needed, the governor added, which means that consumer spending has to account for a smaller share of the British economy’s growth rate and exports a larger share.

Adapted from Larry Elliott �Strong pound burns a hole in our pockets’ The Guardian 19 November 2007.

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Figure1:TheUK’sBalanceoftradeintravelandtourism(£billion,2006prices)

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Extract2 Tourism

A quarter of a century ago Britain had a balance of payments surplus on travel and tourism. Now we have a deficit which is partly attributable to rising prosperity. The UK tourism deficit with North America is £750 million. With Europe it is £12.7 billion, and with the rest of the world, £5.9 billion.

Could this be beginning to change? There are some reasons for thinking so. First, holidaying in Britain may become more fashionable as a result of television shows such as Coast, Mountain and Britain’s Favourite View. Secondly, it is just possible that people are responding to the exhortation to be more green and travel less by plane. This could go much further if future green taxes were to increase the cost of overseas travel. Thirdly, while the quality of Britain’s weather has not improved, the quality of Britain’s holiday accommodation has. Fourthly, the 2012 Olympic Games are regarded by the tourist industry as a once-in-a-generation opportunity to boost visits to Britain. As a result of winning the bid for the Games, many other events and conferences – most unrelated to sport – have been secured for the UK.

The tourism economy is worth £85 billion a year. A closing of Britain’s tourist deficit would have a significant economic impact, eliminating nearly half of the current account deficit.Adapted from David Smith �Holiday at Home and do your bit for blighty’ in The Sunday Times 26 August 2007

(a) What is meant by a �fixed exchange rate’ (Extract 1, lines 3 – 4)?

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(b) With reference to the first paragraph of Extract 1, assess the impact of a devaluation or depreciation in the external value of a currency on the balance of payments deficit on current account.

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(c) Apart from the impact on the current account of the balance of payments, outline two possible effects of a sharp fall in the external value of the pound.

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(d) (i) With reference to Figure 1, assess the factors which might explain the deterioration in the UK’s balance of trade in travel and tourism.

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(d) (ii) With reference to Extract 2, evaluate two factors which could help to reduce the deficit on the travel and tourism account.

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(e) To what extent should a deficit on the current account of the balance payments be of concern to policymakers?

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