prompt 3 - (Prices are rising too fast)

Q: What is the UK’s main macroeconomic problem in this scenario?

A: High inflation caused by a negative supply shock from rising global energy prices, creating stagflationary pressures.

Q: How does the AD–AS model explain the inflation problem?

A: Higher energy costs shift short-run aggregate supply (SRAS) left, causing prices to rise while output and employment fall.

Q: Why is this situation difficult for policymakers?

A: Lowering inflation can slow economic growth and increase unemployment, creating a tradeoff.

Q: What fiscal policy should the UK government use?

A: Targeted fiscal policy such as energy subsidies, transfer payments, and investment in domestic energy infrastructure.

Q: Why should the government avoid broad tax cuts or large spending increases?

A: They could increase aggregate demand too much, worsening inflation and government debt.

Q: What monetary policy should the Bank of England use?

A: Maintain relatively high interest rates to reduce consumer spending and investment, helping lower inflation.

Q: What indicators should policymakers monitor?

A: CPI inflation, wage growth, and unemployment trends.

main idea

Inflation is rising because of a supply shock from energy prices, so the government should use targeted fiscal support while the central bank keeps interest rates high to reduce inflation without causing a severe recession.