case study:

On 4 May 2018, Argentina's central bank raised interest rates to 40%. The day before this increase they were raised from 30.25% to 33.25%. A week earlier, they were raised from 27.25%. The rises were aimed at supporting Argentina's currency, the peso, which lost a quarter of its value over the previous year. Despite these rises, the peso, which before the economic turmoil in Argentina in 2001-2002 was fixed at parity with the US dollar, was trading at about 22 pesos to the US dollar. Risks to the peso had been developing for some time. These included large budget and current account deficits, a heavy government debt burden, persistent high inflation and an overvalued currency.

Inflation, a long-standing problem in Argentina, was 25% in 2017, the highest annual rate in South America except for Venezuela. The central bank has set an annual inflation target of 15% and has stated it will continue to take measures to achieve it.

Argentina's new president is pursuing a pro-market economic reform programme, seeking to reverse the protectionism and high government spending of previous governments. The president has pledged to reduce government spending drastically. The political opposition wants to stop him from removing subsidies on a range of basic household products, including gas and electricity. Removing the subsidies may bring more inflation in the short term but could help bring it down from its current high level to an annual rate of about 5% by 2020.

International and domestic investors still believe the president has a good plan for Argentina's economic recovery, but they are not convinced he has enough political support to achieve it.

question:

-Use aggregate demand and aggregate supply analysis to explain how the recent interest rate rises might help Argentina to reduce its annual rate of inflation and achieve its target. (6)