3.5 Monetary policy questions for IB Economics
147 questions on Monetary policy, written by Augment in the style of IB exam papers. Six of them are below in full, to answer on paper.
- IB Economics
- Part of 3 Macroeconomics
- SL and HL
Questions by paper and level
SL and HL questions are for students at either level. HL only questions cover what only HL students study.
| Paper | SL and HL | HL only | All |
|---|---|---|---|
| Paper 1 | 33 | 13 | 46 |
| Paper 2 | 53 | 19 | 72 |
| Paper 3HL only | 0 | 29 | 29 |
| Every paper | 86 | 61 | 147 |
Counted on
Questions to try
Written by Augment in the style of IB exams, not past papers. Answer them on paper, then check each one against its markscheme with a free account.
Inflation in an economy has risen to 7%, well above the central bank’s target of 2%.
- (a)
Explain how a central bank can use contractionary monetary policy to reduce inflation.
10 marks
- (b)
Using real-world examples, evaluate the effectiveness of monetary policy in reducing inflation.
15 marks
Read the extracts and answer the questions that follow.
Text A — Overview of Rendalia
[1] Rendalia is a lower-middle-income economy in South America with a population of 31 million. Agriculture employs about a quarter of the labour force, and soybeans are its largest export, followed by beef and timber. Tourism, centred on the rainforests and wetlands of the south, has become the fastest-growing source of foreign exchange.
[2] Between 2015 and 2025 the world price of soybeans fell, and foreign investors withdrew funds from Rendalia. As a result, the rendal (RDL) experienced a depreciation against the US dollar (Table 1). Because Rendalia imports most of its fuel and fertilizer, the weaker currency raised firms' costs and inflation rose sharply.
[3] In 2025 the central bank raised its policy interest rate from 5 % to 11 % in an attempt to bring inflation back to its target of 3–5 %. Business groups warned that higher borrowing costs would slow investment and job creation at a time when unemployment was already rising.
[4] Despite slower growth, the share of the population living in extreme poverty has continued to fall, helped by a cash transfer programme for rural households. Inequality remains high, however, particularly between the prosperous soy-growing north and the poorer, more remote south, where many households depend on small-scale farming and seasonal tourism work.
[5] The government's budget deficit widened to 4.8 % of GDP in 2025 as spending on the cash transfer programme rose and revenue from taxes on trade fell. Credit rating agencies have warned that further increases in government debt could raise the cost of borrowing.
Table 1: Economic data for Rendalia
Indicator | 2015 | 2025 |
|---|---|---|
Real GDP growth (annual %) | 4.1 | 2.3 |
Inflation (annual % change in CPI) | 3.2 | 9.4 |
Unemployment (% of labour force) | 6.5 | 8.1 |
Exchange rate (RDL per US$) | 4.00 | 6.00 |
Population in extreme poverty (%) | 14.0 | 11.5 |
Text B — Soy, forests and soil in the Northern Province
[1] Rendalia's Northern Province contains large areas of tropical forest. Over the past decade, soy farms have expanded rapidly into the forest. Fertile, cleared land has become increasingly scarce, and each new farm must be carved out of forest on poorer, more distant land.
[2] The price of cleared farmland in the province has more than doubled since 2015. Smaller farmers, unable to afford land close to roads and ports, have moved deeper into the forest, where transport costs are higher and yields are lower.
[3] Agricultural economists have estimated the combinations of soybeans and forest products (timber, nuts and resins harvested sustainably) that the province could produce each year if all of its land, labour and capital were fully employed (Table 2).
[4] Clearing the forest has consequences beyond the farms themselves. Without tree cover, heavy rains wash away topsoil, reducing yields on existing farms and filling rivers with silt that damages fisheries downstream. Indigenous communities who depend on the forest for food and income have lost land, and the burning that accompanies clearance releases large quantities of carbon dioxide.
Table 2: Production possibilities of the Northern Province (per year)
Combination | Soybeans (thousand tonnes) | Forest products (thousand cubic metres) |
|---|---|---|
A | 0 | 500 |
B | 200 | 460 |
C | 400 | 360 |
D | 600 | 200 |
E | 800 | 0 |
Text C — A new strategy for growth
[1] In 2025 Rendalia's government announced a new strategy. A 5 % tax will be charged on the value of soybean exports. Half of the revenue will fund payments to landowners who keep forest standing, and the other half will pay for rural roads, agricultural research to raise yields on existing farmland, and training for workers in ecotourism.
[2] Soy producers argue that the tax will make them less competitive against producers in other countries and reduce export earnings. Environmental groups say the payments for keeping forest are too low to stop clearing. Tourism operators welcome the plan; a hotel night in a southern eco-lodge costs RDL 360, and they say the weaker rendal has made Rendalia an attractive destination for foreign visitors.
- (a)(i)
Define the term depreciation indicated in bold in the text (Text A, paragraph 2).
2 marks
- (a)(ii)
Define the term scarce indicated in bold in the text (Text B, paragraph 1).
2 marks
- (b)(i)
Using information from Table 2, calculate the opportunity cost of one tonne of soybeans when the Northern Province moves from combination C to combination D.
2 marks
- (b)(ii)
Using information from Table 2, state whether the opportunity cost of soybeans rises, falls or stays the same as more soybeans are produced.
1 mark
- (b)(iii)
Using information from Table 1 and Text C, paragraph 2, calculate the price in US$ of a hotel night in a southern eco-lodge in 2025.
2 marks
- (c)
Using an AD/AS diagram, explain how the central bank's increase in its interest rate is likely to affect inflation in Rendalia (Text A, paragraph 3).
4 marks
- (d)
Using an exchange rate diagram, explain why the rendal depreciated between 2015 and 2025 (Text A, paragraph 2 and Table 1).
4 marks
- (e)
Using a production possibilities curve (PPC) diagram, explain how soil erosion could affect the Northern Province's production possibilities (Text B, paragraph 4).
4 marks
- (f)
Using an externalities diagram, explain why the expansion of soy farming into the forest leads to a welfare loss (Text B, paragraph 4).
4 marks
- (g)
Using information from the text/data and your knowledge of economics, evaluate the government's new strategy (Text C) as a way of achieving economic growth and sustainable development in Rendalia.
15 marks
A banking crisis in Country X
Country X is a high-income economy with a population of 9.8 million. Between 2019 and 2023, its two largest banks, Arvel Bank and Tremont Bank, expanded lending to property developers rapidly. Senior managers received large annual bonuses linked to the growth of their banks' profits in that year.
When property prices fell by 28 % in 2024, many developers could not repay their loans. Because the two banks hold more than half of all household deposits, the government decided that they were 'too big to fail' and in 2025 rescued them at a cost of US$28 billion, financed by government borrowing.
Table 1: Selected economic data for Country X
2024 | 2025 | |
|---|---|---|
Nominal GDP (US$ billion) | 400 | 392 |
Government debt (US$ billion) | 220 | 262 |
Inflation rate (annual % change in CPI) | 2.6 | 1.8 |
Central bank policy interest rate (%) | 3.0 | 0.5 |
- (a)(i)
Using Table 1, calculate the change in government debt as a percentage of GDP between 2024 and 2025, in percentage points.
2 marks
- (a)(ii)
Using Table 1, calculate the cost of the bank rescue as a percentage of GDP in 2025.
1 mark
- (a)(iii)
Calculate the cost of the bank rescue per person in Country X.
2 marks
- (a)(iv)
Using Table 1, calculate the real interest rate in Country X in 2025.
1 mark
- (a)(v)
Define the term moral hazard.
2 marks
- (a)(vi)
Using the information provided, explain two reasons why the rescue of Arvel Bank and Tremont Bank may increase risk-taking in Country X's banking sector in the future.
4 marks
- (a)(vii)
After the crisis, investment in Country X is expected to fall by US$6 billion. The marginal propensity to save is 0.08, the marginal rate of taxation is 0.20 and the marginal propensity to import is 0.12.
Calculate the maximum change in real GDP that could result from the fall in investment.
2 marks
- (a)(viii)
Using an AD/AS diagram, explain the likely effect of the fall in investment on real GDP and unemployment in Country X.
4 marks
- (a)(ix)
Outline how requiring part of bankers' bonuses to be paid several years later, and to be cancelled if losses occur, could reduce moral hazard.
2 marks
- (b)
The financial regulator of Country X is considering the following measures:
Higher capital requirements: large banks would have to hold capital (shareholders' funds) equal to 13 % of their risk-weighted assets instead of 8 %; banks warn that lending to small firms could fall by up to 6 %.
Bail-in rules: in any future failure, the banks' bondholders and large depositors (above US$100 000) would bear losses before any taxpayer money is used; critics say a government may not keep this promise in a crisis.
Limits on property lending: loans to property developers could not exceed 15 % of a bank's total lending; Arvel Bank's share reached 34 % in 2023.
Bonus rules: at least half of senior managers' bonuses would be deferred for five years and could be cancelled if losses occur; senior staff might move to banks in other countries.
Breaking up the largest banks: each would be split into two or more smaller banks; this would take several years and could raise banks' costs.
Using the information provided and your knowledge of economics, recommend a policy that the financial regulator of Country X could introduce to reduce moral hazard in the banking sector.
10 marks
In a modern economy, households, firms, the government, banks and foreign buyers and sellers are linked through flows of money.
- (a)
Explain how the financial sector and the foreign sector create interdependence between decision-makers in the circular flow of income.
10 marks
- (b)
Using real-world examples, discuss the effectiveness of lower interest rates in increasing investment and real GDP.
15 marks
Read the extract and answer the questions that follow.
Text A — Sardova's recession divides its advisers
[1] Sardova, a high-income economy with a population of 9 million, entered recession in 2024. Real GDP fell by 2.6 % and the unemployment rate rose from 4.8 % to 7.9 %. Inflation fell to 0.5 %, and the economy is estimated to have a deflationary (recessionary) gap equal to about 3 % of potential output.
[2] The central bank's policy interest rate is 3.0 %. Two members of the government's economic council disagree about what should be done.
[3] Adviser A, who follows the Keynesian approach, argues that weak consumer confidence will keep spending low for several years. She wants the central bank to cut its policy rate to 1.0 % immediately, supported by higher government spending on infrastructure.
[4] Adviser B, who follows the monetarist/new classical approach, points out that money wages are already falling in construction and manufacturing, and argues that "the economy will correct itself within two years". He warns that cutting interest rates would only cause inflation once the recovery begins.
- (a)
Define the term deflationary (recessionary) gap indicated in bold in the text (Text A, paragraph 1).
2 marks
- (b)
Using information from Text A, calculate the real interest rate in Sardova in 2024.
2 marks
- (c)
Using an AD/AS diagram, explain how the cut in interest rates proposed by Adviser A could reduce unemployment in Sardova (Text A, paragraph 3).
4 marks
- (d)
Using an AD/AS diagram, explain how, according to Adviser B, Sardova's economy will return to its potential output without intervention (Text A, paragraph 4).
4 marks
- (e)
Using information from Text A, explain two reasons why Adviser A and Adviser B reach different conclusions about the same economy.
4 marks
Recession in Country X
Country X is a high-income economy with a population of about 32 million. A fall in house prices in 2023, followed by weaker demand from its main trading partners, led to a fall in real GDP in 2024. Unemployment rose from 4.9 % to 7.3 %, while inflation fell to 1.2 %, below the central bank's target of 2 %.
Table 1 shows selected national income data for Country X.
Table 1: Selected data for Country X
Year | Nominal GDP (US$ billion) | GDP deflator (base year 2020 = 100) | Population (million) |
|---|---|---|---|
2023 | 864.00 | 108.0 | 32.0 |
2024 | 870.24 | 111.0 | 32.4 |
- (a)(i)
Using the information in Table 1, calculate Country X's real GDP per capita in 2024 (in US$, at 2020 prices).
2 marks
- (a)(ii)
Using the information in Table 1, calculate the rate of economic growth in Country X in 2024.
2 marks
- (a)(iii)
The central bank estimates that Country X's potential output in 2024 was US$812 billion (at 2020 prices).
Using your answer to part (a)(i), calculate the output gap in 2024 as a percentage of potential output.
2 marks
- (a)(iv)
Economists estimate that in Country X the marginal propensity to save (MPS) is 0.15, the marginal propensity to tax (MPT) is 0.20 and the marginal propensity to import (MPM) is 0.25.
Calculate the value of the Keynesian multiplier for Country X.
2 marks
- (a)(v)
Using your answer to part (a)(iv) and the information in part (a)(iii), calculate the increase in government spending needed to close the output gap, assuming the price level is constant.
2 marks
- (a)(vi)
Using an AD/AS diagram and the information provided, explain how an increase in government spending could close the deflationary (recessionary) gap in Country X.
4 marks
- (a)(vii)
At the end of 2024, Country X's government (national) debt was US$620 billion.
Using the information in Table 1, calculate Country X's government debt as a percentage of GDP in 2024.
2 marks
- (a)(viii)
Explain two reasons why an increase in government spending might not close Country X's deflationary (recessionary) gap.
4 marks
- (b)
Further information:
The central bank's policy interest rate is 1.0 %. Household debt is high, at 135 % of disposable income, and surveys show that many households plan to reduce their borrowing.
Ratings agencies have warned that Country X's credit rating could be lowered if government debt rises above 75 % of GDP.
The government has a list of road, rail and broadband projects that have already been approved, worth US$9 billion, which could start within six months.
A temporary cut in the rate of income tax for low-income households would cost US$12 billion; low-income households spend a large share of any extra income.
Country X's currency floats freely. Its main trading partners are expected to recover slowly in 2025.
Using the information provided and your knowledge of economics, recommend a policy the government of Country X could introduce to close its deflationary (recessionary) gap.
10 marks
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More questions in Macroeconomics
- 3.1Measuring economic activity
- 3.2Aggregate demand and aggregate supply
- 3.3Macroeconomic objectives
- 3.4Economics of inequality and poverty
- 3.5Monetary policyThis page
- 3.6Fiscal policy
- 3.7Supply-side policies
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