CFA Economic Analysis & Indicators 2 — Questions and Answers
Question 1: Which of the following best describes the relationship between the output gap and inflation according to the Phillips Curve?
- A positive output gap (actual > potential) tends to push inflation higher (Correct answer)
- A negative output gap always causes deflation
- The output gap has no relationship to inflation in modern economies
- A positive output gap always reduces inflation by increasing supply
Correct answer: A positive output gap (actual > potential) tends to push inflation higher
When actual output exceeds potential (positive output gap), resource constraints and demand pressure tend to push inflation upward.
Question 2: The Conference Board's Leading Economic Index (LEI) for the U.S. includes which of the following components?
- Average weekly manufacturing hours and building permits (Correct answer)
- Current unemployment rate and retail sales
- Current GDP and trade balance
- Federal funds rate and current CPI
Correct answer: Average weekly manufacturing hours and building permits
The LEI includes forward-looking components such as average weekly manufacturing hours, building permits, and stock prices that signal future economic direction.
Question 3: A country reports a current account deficit of $50 billion. According to the balance of payments identity, what must be true?
- The financial and capital account must show a net surplus of approximately $50 billion (Correct answer)
- The country must be running a budget surplus
- Foreign direct investment into the country must equal $50 billion
- The country's currency must be appreciating
Correct answer: The financial and capital account must show a net surplus of approximately $50 billion
The balance of payments must sum to zero, so a current account deficit must be offset by a financial/capital account surplus of equal magnitude.
Question 4: In the context of economic indicators, the term 'diffusion index' is most closely associated with:
- ISM manufacturing and services surveys that measure the breadth of expansion or contraction (Correct answer)
- A measure of how widely inflation has spread across consumer goods categories
- A Federal Reserve tool for measuring credit conditions
- An index tracking how many sectors of the S&P 500 are outperforming
Correct answer: ISM manufacturing and services surveys that measure the breadth of expansion or contraction
Diffusion indexes, like the ISM PMI, measure the percentage of respondents reporting expansion minus those reporting contraction, indicating breadth of economic change.
Question 5: Which economic concept explains why a 1% increase in consumer income might lead to a greater-than-1% increase in GDP?
- The Keynesian multiplier effect (Correct answer)
- The accelerator principle
- Ricardian equivalence
- Say's Law
Correct answer: The Keynesian multiplier effect
The Keynesian multiplier holds that an initial injection of spending circulates through the economy, creating a total GDP increase larger than the original stimulus.
Question 6: When the yield curve inverts (short-term rates exceed long-term rates), the most common CFA-level interpretation is:
- Financial markets are pricing in future economic slowdown or recession (Correct answer)
- Inflation expectations are rising sharply
- The central bank has lost control of monetary policy
- Long-term bonds have become riskier than short-term bonds
Correct answer: Financial markets are pricing in future economic slowdown or recession
An inverted yield curve historically precedes recessions because it reflects market expectations of falling future short-term rates due to economic weakness.
Question 7: Total Factor Productivity (TFP) in the Solow growth model represents:
- The portion of output growth not explained by increases in capital or labor inputs (Correct answer)
- The ratio of capital to labor in the production function
- The steady-state level of per capita output
- The depreciation rate of the capital stock
Correct answer: The portion of output growth not explained by increases in capital or labor inputs
TFP, sometimes called the 'Solow residual,' captures efficiency gains, technological progress, and other factors beyond measured inputs.
CFA Economic Analysis & Indicators 2
Which of the following best describes the relationship between the output gap and inflation according to the Phillips Curve?