For each of the scenarios, recommend an interest rate decision, justify it briefly (explaining any concerns that you have) and illustrate how your decision is likely to help using an AD/AS diagram.

Scenario 1

CPI inflation last month stood at 4.2% as labour shortages in the retail sector fed through into higher labour costs. Consumer confidence is high after ten years of uninterrupted GDP growth, with unemployment at an all-time low. The weak pound has contributed to rising export growth, although firms in chemicals and light engineering have been concerned about the impact on their cost base.

Scenario 2

CPI inflation last month stood at 4.2%, well above the Central Bank’s target, having risen sharply from 3.5% the previous month as a result of higher commodity costs caused by global supply issues in rice, wheat and petroleum. Consumers have been concerned by fears of rising unemployment as troubles in the Eurozone have caused export orders to slip slightly. The zone is expected to continue to contract over the next twelve months. Unemployment rose sharply in the last quarter as consumers have cut back on purchases due to low confidence. GDP growth is forecast to fall sharply.

Scenario 3

CPI inflation last month stood at 4.2% in spite of plummeting consumer confidence and a sharp fall in orders in both manufacturing and construction. Sterling collapsed to a ten year low against the Euro and the dollar on the announcement of the news. Prices have been driven by political turmoil in the middle East, causing a spike in oil prices. Rapid growth in the BRIC economies is expected to drive oil prices higher, whilst economic and population growth are expected to drive up agricultural commodity prices as well.