The Eurozone economy Figure 1: Exchange rate of the euro (€) to the British pound (£) Figure 2: Eurozone inflation rate as measured by the Consumer Prices Index (CPI) Extract A European Central Bank disappoints markets with weaker than expected stimulus Mario Draghi, president of the European Central Bank (ECB), surprised financial markets in November 2015 with a less ambitious package of monetary stimulus than many had anticipated - Edexcel - A-Level Economics A - Question 6 - 2017 - Paper 2

Two factors that may explain the change in the rate of Eurozone inflation from 2011 to 2015 include:

1. Monetary Policy of the ECB

The European Central Bank's monetary policy plays a crucial role in determining inflation rates. In 2015, Mario Draghi announced a package of monetary stimulus that included a reduction in the base interest rate and an extension of the QE program. By cutting interest rates, the ECB aimed to encourage borrowing and spending, thereby increasing demand and, consequently, inflation. However, if these measures were perceived as inadequate or if economic recovery was sluggish, inflation could remain low, as observed in the declining trend from 2011 to 2015.

2. Global Economic Conditions

Global economic conditions also significantly impact inflation. Between 2011 and 2015, the Eurozone experienced external challenges such as the effects of the global financial crisis and fluctuating oil prices. Falling oil prices, for example, can decrease the overall price level, leading to lower inflation rates. As oil is a major component in consumer spending, a significant drop in oil price would directly lead to reduced transportation costs and subsequently lower prices in the broader economy.

The appreciation of the euro since mid-2015 can have both positive and negative impacts on the current account of the balance of payments for Eurozone countries:

Positive Impacts:

1. Stronger European Purchasing Power: A stronger euro makes imports cheaper for Eurozone countries, potentially increasing the volume of imported goods, which could benefit consumers and businesses relying on foreign products and inputs.

Negative Impacts:

2. Export Competitiveness: On the flip side, a stronger euro makes European exports more expensive for foreign buyers, which can lead to a decline in export volumes. This drop in exports may negatively affect the current account balance, as a reduction in export earnings will increase the trade deficit or decrease the surplus.

Overall, while a stronger euro could enhance purchasing power, its negative impact on export competitiveness may outweigh the benefits, leading potentially to a deterioration of the current account balance.

The ECB’s quantitative easing (QE) program has had mixed success in moving Eurozone inflation closer to the target of around 2%.

Assessment of Success:

1. Initial Impact: Initially, the QE program aimed to inject liquidity into the economy, thereby boosting lending and increasing consumer spending. This was expected to lift inflation, as an increase in demand typically correlates with rising prices.

2. Challenges: Despite these efforts, inflation rates remained below the ECB’s target. Persistently low inflation suggests that the QE measures alone were insufficient. Factors such as slow economic growth, falling oil prices, and structural issues within the Eurozone economy likely hampered the efficacy of the program.

Overall, while QE was a critical step towards stimulating the economy, reliance on it without complementary fiscal policies and structural reforms appears to limit its effectiveness in raising inflation rates to target levels.

Governments in Eurozone countries may consider the following 'looser fiscal policy' and 'supply-side reforms' to stimulate economic growth:

Looser Fiscal Policy:

1. Increased Government Spending: This may involve higher public investments in infrastructure projects, education, and healthcare, which can spur job creation and stimulate demand in the economy. Higher spending can directly boost economic activity and employment rates.

2. Tax Incentives: Reducing taxes can increase disposable income for consumers and higher after-tax profits for businesses. This can encourage spending and investment, leading to higher economic growth.

Supply-Side Reforms:

1. Labor Market Reforms: Making labor markets more flexible, such as reducing hiring and firing costs or improving vocational training programs, can increase employment and enhance productivity.

2. Regulatory Reforms: Streamlining regulations to ease the burden on businesses can encourage entrepreneurship and investment, which are crucial for long-term economic growth.

In conclusion, a combination of looser fiscal policies and effective supply-side reforms can significantly contribute to boosting the Eurozone economy's growth potential.