Is it possible to decrease inflation without causing a recession and its concomitant increase in unemployment? The orthodox answer is...
GMAT Reading Comprehension : (RC) Questions
Is it possible to decrease inflation without causing a recession and its concomitant increase in unemployment? The orthodox answer is "no." whether they support the "inertia" theory of inflation (that today's inflation rate is caused by yesterday's inflation, the state of the economic cycle, and external influences such as import prices) or the "rational expectations" theory (that inflation is caused by workers' and employers' expectations, coupled with a lack of credible monetary and fiscal policies), most economists agree that tight monetary and fiscal policies, which cause recessions, are necessary to decelerate inflation. They point out that in the 1980's, many European countries and the United States conquered high (by these countries' standards) inflation, but only by applying tight monetary and fiscal policies that sharply increased unemployment. Nevertheless, some governments' policymakers insist that direct controls on wages and prices, without tight monetary and fiscal policies, can succeed in decreasing inflation. Unfortunately, because this approach fails to deal with the underlying causes of inflation, wage and price controls eventually collapse, the hitherto-repressed inflation resurfaces, and in the meantime, though the policymakers succeed in avoiding a recession, a frozen structure of relative prices imposes distortions that do damage to the economy's prospects for long-term growth.
The passage suggests that the high inflation in the United States and many European countries in the 1980's differed from inflation elsewhere in which of the following ways?
3. Question Analysis:
This question asks us to identify how inflation in the US and European countries during the 1980s differed from inflation elsewhere. The key is to look for what made the 1980s inflation in these specific countries distinctive compared to inflation in other places or times.
Connecting to Our Passage Analysis:
From our passage analysis, we know that:
- The passage mentions that in the 1980s, "many European countries and the United States conquered high (by these countries' standards) inflation"
- The phrase "by these countries' standards" is crucial - it suggests a relative comparison
- The passage uses this 1980s example as evidence supporting the orthodox economic view that tight policies are necessary to fight inflation
- The passage doesn't suggest these countries had unique theories or easier solutions - quite the opposite, they had to use the same difficult approach (tight monetary and fiscal policies)
Prethinking:
The key phrase "by these countries' standards" strongly suggests that what was considered "high" inflation in the US and Europe might not be considered high elsewhere. This implies a relative standard - these developed countries had lower tolerance for inflation levels that might be normal or even low in other parts of the world. This interpretation aligns with economic reality where developing countries often experience much higher inflation rates than developed nations.
Why It's Wrong:
- The passage states that "whether they support the 'inertia' theory... or the 'rational expectations' theory... most economists agree" on the same solution
- There's no indication that 1980s inflation fit one theory better than another
- The passage presents both theories as explaining the same orthodox approach used in the 1980s
Common Student Mistakes:
- Did you think the passage was comparing different theories for different time periods?
→ The theories are presented as alternative explanations for the same phenomena, not as applying to different situations - Did you focus too much on the theoretical details instead of the main point?
→ Remember both theories lead to the same "orthodox answer" regardless of time or place
Why It's Wrong:
- The passage explicitly states these countries "conquered high inflation... but only by applying tight monetary and fiscal policies that sharply increased unemployment"
- This directly contradicts the idea that it was possible to control without causing recession
- The 1980s example is used specifically to prove that recession was necessary
Common Student Mistakes:
- Did you misread "conquered" as meaning they found an easy solution?
→ "Conquered" here means they succeeded, but the passage emphasizes it was "only by" using harsh measures - Did you confuse this with the failed wage and price controls approach?
→ The 1980s example supports orthodox economics, while wage/price controls are the failed alternative
Why It's Wrong:
- Nothing in the passage suggests it was easier to control inflation in these countries
- The passage indicates they used the same difficult orthodox approach that economic theory predicts
- The phrase "sharply increased unemployment" suggests it was quite difficult and painful
Common Student Mistakes:
- Did you think "conquered" implied it was easier for them?
→ Success doesn't mean ease - they succeeded by accepting the painful orthodox solution - Did you assume developed countries have better tools?
→ The passage suggests the same economic principles apply universally
Why It's Wrong:
- The passage doesn't distinguish 1980s inflation from other inflation based on its causes
- Both inflation theories (including rational expectations) are presented as general explanations, not specific to certain times or places
- There's no suggestion that workers' and employers' expectations were irrelevant in the 1980s
Common Student Mistakes:
- Did you think the passage was saying different types of inflation have different causes?
→ The theories are alternative explanations for inflation generally, not for specific instances - Did you focus on the theoretical details rather than the comparative aspect of the question?
→ Look for what made 1980s inflation distinctive, not what theory explains it
Why It's Right:
- The key phrase "by these countries' standards" directly indicates a relative comparison
- This suggests what was "high" inflation for the US and Europe might be normal or low elsewhere
- This interpretation makes economic sense given that developed countries typically have lower inflation tolerance than developing nations
Key Evidence: "many European countries and the United States conquered high (by these countries' standards) inflation"