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 critical factors that help explain the change in the inflation rate in the Eurozone as illustrated in Figure 2 are:

1. Change in Monetary Policy: The European Central Bank's (ECB) decision to implement quantitative easing (QE) significantly influenced inflation rates. By lowering interest rates and purchasing government bonds, the ECB aimed to boost liquidity and stimulate spending. Initially, these policies led to higher inflation rates; however, by 2015, the effectiveness of these measures diminished, causing a decline in inflation.

2. External Economic Conditions: Factors such as falling oil prices also contributed to the decrease in inflation rates. Globally, a significant drop in oil prices reduced energy costs, which in turn lowered the consumer price index (CPI) and contributed to lower inflation readings. This trend can lead to reduced consumer confidence and spending, further impacting inflation negatively.

The appreciation of the euro is likely to have a mixed impact on the current account balance of payments for Eurozone countries:

1. Imports and Exports: A stronger euro makes imports cheaper and exports more expensive. As the cost of Eurozone exports rises in foreign markets, demand may decrease, leading to a potential worsening of the trade balance. Conversely, cheaper imports can boost domestic consumption, leading to higher import volumes.

2. Competitiveness: The appreciation can negatively impact the competitiveness of Eurozone countries in global markets. This could result in trade deficits as domestic goods become less attractive to foreign consumers, thereby affecting the current account negatively.

The likely success of the ECB's quantitative easing (QE) programme in raising Eurozone inflation to the target level is contingent upon several factors:

1. Effectiveness of QE: QE has shown some effectiveness in stimulating demand by encouraging banks to lend more, which can lead to increased spending by consumers. However, if financial institutions do not respond adequately to these lower interest rates, the desired effect on inflation may not materialize.

2. External Factors: External economic factors such as global economic conditions, oil prices, and geopolitical uncertainties can also influence inflation rates. The ECB’s measures might be undermined by external shocks, which can limit the inflationary impact intended by QE.

Looser fiscal policy and supply-side reforms are two pivotal strategies that governments within the Eurozone can employ:

1. Looser Fiscal Policy: This approach involves increasing government spending or reducing taxes to stimulate aggregate demand. By supporting public projects and social services, governments can inject money into the economy, enhance consumer confidence, and ultimately drive economic growth.

2. Supply-Side Reforms: These reforms aim at improving the efficiency and productivity of the economy. This includes measures such as reducing regulations, enhancing workforce skills through education and training, and investing in infrastructure. These reforms can help create a more conducive environment for businesses, leading to increased investment and job creation, which can support economic growth.