OCR A Level Economics: Monetary policy and inflation targeting (H460) – Practice Questions

These are original questions written for Marlbridge, for revision and practice on this content. They are not reproduced past-paper questions, and they do not replicate the exam’s exact structure, question count or mark tariffs – examination boards hold copyright in their own papers. Use these alongside the official past papers from your board or school.

These questions cover the Monetary policy topic of the OCR A Level Economics (H460) specification, Version 3.0 (June 2026), for first assessment in 2021, macroeconomics content. The specification labels no content as a separate stage. All data are invented and illustrative: Country M and its currency, the mu, are fictional.

Read the study guide and revision notes first. See also the OCR Economics hub, the checklist and the free diagnostics.

Questions

1. The consumer price index in Country M rises from 131.2 to 134.5 over a year. The central bank has a symmetric inflation target of 2%. Calculate the rate of inflation to one decimal place and state how far it is from the target. [3]

2. A saver in Country M earns a nominal interest rate of 2.5% while inflation is 3.5%.

(a) Calculate the approximate real interest rate. [1] (b) Explain how this real rate may affect the saver’s behaviour. [2]

3. Country M’s central bank announces quantitative easing. A bond with a face value of 100 mu pays a coupon of 5 mu a year and is priced at 100 mu. Bond purchases raise its price to 108 mu.

(a) Calculate the yield before and after, to two decimal places. [2] (b) Explain how quantitative easing may increase the money supply and aggregate demand. [3]

4. The mu falls from 1.60 to 1.40 foreign units (fu).

(a) Calculate by what percentage the mu has changed against the fu. [1] (b) An export is priced at 250 mu. Calculate its price in fu before and after the change. [2] (c) Explain the likely effect on aggregate demand. [2]

5. Explain what is meant by a liquidity trap and why a further cut in the policy rate may not raise spending. [4]

6. A cut in Country M’s policy rate raises consumption by 3.0 billion mu, investment by 1.5 billion and net exports by 0.5 billion. The marginal propensity to withdraw is 0.4. Real GDP is 400 billion.

(a) Calculate the initial change in aggregate demand. [1] (b) Calculate the multiplier. [1] (c) Calculate the final change in output. [1] (d) Express the final change as a share of real GDP, to one decimal place. [1] (e) Explain two reasons why the actual rise in output may be smaller. [2]

7. Country M’s target is 2.5%. Inflation in four years is 1.5, 2.4, 3.3 and 2.7%.

(a) Distinguish between a symmetric and an asymmetric inflation target. [3] (b) Calculate the deviation from target each year and state which years breach an asymmetric ceiling of 2.5%. [2]

8. Productivity in Country M grows by 2% a year and the central bank’s target is 2.5%.

(a) If workers expect the target to be met, estimate the wage rise they would claim. [1] (b) Explain how a credible inflation target changes the behaviour of workers and of firms. [3]

9. Explain how a central bank works to achieve its inflation target. [6]

10. Country M’s inflation has risen because of higher world energy prices. The central bank is considering raising its policy rate. Evaluate the effectiveness of monetary policy in this situation. [9]

11. Evaluate the view that monetary policy is of little use when interest rates are close to zero. [10]

Answers

1. Inflation = (134.5 − 131.2)/131.2 × 100 [1] = 3.3/131.2 × 100 = 2.5% [1]. This is 0.5 percentage points above the 2% target [1]. [3] Examiner insight: Show the working and quote the answer to the accuracy asked. State the gap in percentage points, because “0.5%” can read as a relative change.

2. (a) 2.5 − 3.5 = −1.0% [1]. (b) The real return is negative, so saving loses purchasing power [1]. The saver has an incentive to spend now or move into assets such as property, which raises consumption [1]. [3] Examiner insight: A clear “so what” about behaviour is needed after the number. Stopping at “the rate is negative” leaves the explanation incomplete.

3. (a) Before: 5/100 = 5.00% [1]. After: 5/108 = 4.63% [1]. (b) The central bank creates electronic money to buy bonds from financial institutions, who now hold more deposits and reserves, so the money supply rises [1]. Lower yields reduce the cost of borrowing and raise asset prices and wealth [1]. Consumption and investment increase, so AD shifts right [1]. [5] Examiner insight: Say who sells the bonds and where the new money ends up. A statement that QE “prints money” without that detail is vague.

4. (a) (1.40 − 1.60)/1.60 = −12.5% [1]. (b) Before: 250 × 1.60 = 400 fu [1]. After: 250 × 1.40 = 350 fu [1]. (c) Exports are cheaper abroad and imports dearer at home, so export demand rises and import demand falls [1]. Net exports rise, so AD shifts right (the size depends on elasticities) [1]. [5] Examiner insight: Decide which way the currency moved before converting any price. A fall in the mu lowers the foreign price of exports.

5. A liquidity trap exists when interest rates are very close to zero [1] and people prefer to hold money rather than bonds, so the demand for money is perfectly elastic [1]. A cut cannot lower market rates further, or banks cannot pass it on [1]. Low confidence or expected falling prices mean firms and households still do not borrow or spend [1]. [4] Examiner insight: Define the trap in terms of demand for money and rates near zero, then give a reason for the failure. Saying rates “can’t be cut” is only part of it.

6. (a) 3.0 + 1.5 + 0.5 = 5.0 billion [1]. (b) 1/0.4 = 2.5 [1]. (c) 5.0 × 2.5 = 12.5 billion [1]. (d) 12.5/400 × 100 = 3.1% [1]. (e) Households may save the extra credit, or firms may not invest because of low confidence [1]. Imports may rise more than expected, or time lags may delay the response [1]. [6] Examiner insight: Work through each step in order, because later answers depend on earlier ones. For part (e), give reasons connected to the data, not general doubts.

7. (a) A symmetric target treats inflation above and below the target as equally undesirable [1]. An asymmetric target treats misses in one direction as worse, for example a ceiling [1]. Under a symmetric target the bank has reason to stimulate when inflation is too low, whereas an asymmetric ceiling gives less reason [1]. (b) Deviations: −1.0, −0.1, +0.8, +0.2 points [1]. The ceiling is breached in years 3 and 4 (3.3% and 2.7%) [1]. [5] Examiner insight: Work from the figures supplied. Naming both direction and size of each deviation shows you have applied the definition.

8. (a) 2.0 + 2.5 = 4.5% [1]. (b) Workers: they expect inflation to be near the target, so they ask for smaller rises, which reduces cost-push pressure [1]. Firms: they can plan prices and investment with more confidence [1]. Because wage and price setting is more moderate, the bank needs smaller changes in rates to keep inflation on target [1]. [4] Examiner insight: Tie each behaviour to a specific agent and say why it changes. A general statement that “expectations improve” is weaker.

9. The central bank forecasts inflation and the output gap using data on prices, wages, output and credit [1]. It compares the forecast with the target [1]. A committee votes on the policy rate, raising it if inflation is forecast above target and cutting it if below [1]. Market rates follow, changing borrowing costs, saving, asset prices and the exchange rate [1]. These alter C, I and net exports, shifting AD and bringing inflation back to the target [1]. It announces and explains its decisions to guide expectations, and if rates are at the floor it may use QE [1]. [6] Examiner insight: A chain from forecast to decision to AD to inflation reads better than a list of tools. Include the role of communication.

10. Points on effectiveness:

• A rate rise reduces borrowing, consumption and investment, so AD shifts left and demand-pull pressure falls [1].
• A higher exchange rate lowers the cost of imported goods, partly offsetting the energy price rise [1].
• It signals commitment to the target and keeps expectations anchored, reducing wage-price spirals [1]. Points against:
• The cause is a supply shock, so higher rates do not lower energy costs and instead reduce output and jobs [1].
• Time lags mean the effect may arrive after energy prices have stabilised [1].
• Households with large debts face a harsh squeeze, and exporters suffer from the higher exchange rate [1]. Evaluation: The policy is effective in anchoring expectations and preventing second-round effects, but poor at reversing the initial price rise [1]. Its success depends on whether wages are already rising and on how much spare capacity exists [1]. A judgement that weighs these conditions is needed, and a gradual response may be better than a sharp one [1]. [9] Examiner insight: The key skill is to identify the cause (cost-push) and judge the tool against it. A list of generic limits scores less well than a conclusion tied to the case.

11. Points supporting the view:

• With rates near zero, cuts cannot go further and the demand for money is highly elastic, so the policy rate has little effect [1].
• Households and firms with low confidence do not borrow even at low rates [1].
• Falling prices raise real interest rates, which discourages spending [1]. Points against:
• QE lowers long-term yields and raises asset prices, so spending can still be stimulated [1].
• Forward guidance can shape expectations about future rates [1].
• Monetary policy can still affect the exchange rate through intervention or QE, helping net exports [1].
• Monetary policy may still prevent a worse fall in demand, so its effect is not zero [1]. Evaluation: Conventional rate cuts are of little use, but unconventional tools are not useless, though their effects are less certain and slower [1]. The view is stronger when the cause is a loss of confidence and weaker if banks are healthy and willing to lend [1]. Fiscal policy may do more, but that is a separate matter [1]. [10] Examiner insight: “Little use” is not the same as “no use”. Separate the policy rate from other monetary tools, then reach a judgement.

Where marks are usually lost

• Giving inflation without checking the rounding the question asks for.
• Writing percentage points as percent, or the reverse.
• Reversing the direction of exchange rate effects on export prices.
• Describing QE without saying who sells the bonds and where the money goes.
• Calculating the multiplier from the marginal propensity to consume instead of withdraw.
• Defining a liquidity trap without mentioning rates near zero and demand for money.
• Listing limits of monetary policy without weighing which matters most in the context.
• Treating a symmetric target as only about overshoots.
• Not using the information in the question in evaluation.

Next steps

• Re-read the revision notes and study guide.
• Open the OCR Economics hub and tick off the checklist.
• Take the free 10-minute diagnostics.
• Book a free trial class at /trial/.

Official syllabus

OCR, A Level in Economics (H460) specification, Version 3.0 (June 2026), for first assessment in 2021, Macroeconomics: application of policy instruments, Monetary policy.