Policy & Responses To Shocks

Question 1

What are the 3 main challenges policymakers face when responding to economic shocks? ( Give 1 example too)

Answer 1

1. Inaccurate information – Governments lack perfect data, making it hard to predict crises.
2. Risk and uncertainty – Economic forecasts are often unreliable.
3. External shocks – Uncontrollable global events can derail policies.

Example: 2008 financial crisis – Governments underestimated the risks of mortgage-backed securities.

Question 2

Why is it difficult for governments to predict economic shocks? (Give 3 reasons and 1 example)

Answer 2

• Hindsight bias – Crises seem obvious after they happen, but are hard to spot in real time.
• Complex global linkages – A crisis in one country can spread globally.
• Human irrationality – Investors and policymakers often misjudge risks.

Example: Argentina’s 1998 crisis was triggered by Brazil’s currency devaluation, reducing Argentina’s competitiveness.

Question 3

What are some 4 examples of global economic shocks?

Answer 3

1. 2008 Financial Crisis – US mortgage market collapse led to a global banking crisis.
2. COVID-19 Pandemic (2020) – Supply chain disruptions and global recessions.
3. Oil price shocks – Rising oil prices increase costs and reduce growth (e.g. 1973 oil crisis).
4. Eurozone Crisis (2010s) – Debt crises in Greece, Spain, and Italy impacted global markets.

Question 4

How do governments use fiscal policy to respond to economic shocks? (Give 2 ways and 1 example)

Answer 4

✅ Expansionary fiscal policy (during recessions):
• Increase government spending to stimulate demand.
• Cut taxes to boost disposable income.

❌ Austerity measures (to reduce deficits):
• Reduce government spending.
• Raise taxes to improve fiscal sustainability.

Example: UK cut VAT in 2009 to boost consumer spending after the financial crisis.

Question 5

How do central banks use monetary policy to respond to shocks? (Give 2 pros, 1 cons and 1 example)

Answer 5

✅ Lower interest rates – Encourages borrowing and investment.
✅ Quantitative easing (QE) – Injects money into the economy.
❌ Liquidity traps – If rates are already low, further cuts may have little impact.

Example: UK cut interest rates from 5% to 0.5% in 2008 to support recovery.

Question 6

What is transfer pricing, and how do multinational corporations use it to avoid taxes? (Give 2 ways and 1 example)

Answer 6

• Transfer pricing allows firms to shift profits between countries to reduce tax liability.
• Companies sell goods/services to their own subsidiaries at manipulated prices.
• High profits are reported in low-tax jurisdictions (e.g. Ireland), while losses are reported in high-tax countries (e.g. UK).

Example: Facebook paid only £5.1 million in UK tax in 2017 despite £850 million in revenue.

Question 7

What is global tax competition, and why is it a problem? (Give 2 problems and 1 example)

Answer 7

• Countries cut corporate tax rates to attract businesses and wealthy individuals.
• Can lead to a “race to the bottom”, reducing government tax revenues.
• Causes inequality, as corporations and the rich benefit while public services suffer.

Example: Lewis Hamilton lives in Monaco (0% income tax) to avoid UK taxes.

Question 8

What are 3 common international responses to financial crises? (Also give an example)

Answer 8

1. IMF bailouts – Provides emergency loans to struggling nations.
2. Bank bailouts – Prevents major financial institutions from collapsing.
3. Debt restructuring – Renegotiating repayment terms to avoid defaults.

Example: Greece’s EU bailout required harsh austerity measures to reduce debt.

Question 9

How do countries respond to supply chain disruptions? (Mention 3 ways and 1 example)

Answer 9

1. Stockpiling essential goods – Increases supply security.
2. Diversifying trade partners – Reduces reliance on one country (e.g. China).
3. Investing in domestic production – Strengthens self-sufficiency.

Example: COVID-19 exposed global supply chain weaknesses, leading to calls for reshoring manufacturing.

Question 10

What are the 3 risks of excessive government intervention in markets? (Also mention 1 example)

Answer 10

❌ Distorts price signals – Makes it harder to allocate resources efficiently.
❌ May create long-term inefficiencies – Firms depend on subsidies rather than improving competitiveness.
❌ Can increase inequality – Policies may unintentionally favour one group over another.

Example: India’s food price controls help consumers but hurt farmers by keeping prices artificially low.