CFA Economic Analysis & Indicators 3 — Questions and Answers
Question 1: Which of the following best describes 'stagflation' and which economic framework struggled most to explain it?
- High inflation combined with high unemployment; traditional Keynesian demand-side models (Correct answer)
- High inflation combined with high growth; monetarist models
- Low inflation combined with low unemployment; supply-side models
- Deflation combined with high unemployment; Austrian School models
Correct answer: High inflation combined with high unemployment; traditional Keynesian demand-side models
Stagflation (1970s) combined rising prices with rising unemployment, contradicting the traditional Phillips Curve trade-off central to Keynesian economics.
Question 2: In national income accounting, Gross National Income (GNI) differs from GDP in that GNI:
- Adds net income earned by residents abroad and subtracts income earned by foreigners domestically (Correct answer)
- Excludes government spending and includes only private sector output
- Adjusts GDP for purchasing power parity differences
- Measures output at factor cost rather than market prices
Correct answer: Adds net income earned by residents abroad and subtracts income earned by foreigners domestically
GNI = GDP + income received by residents from abroad − income paid to foreign residents, capturing the nationality rather than geographic basis of income.
Question 3: The 'neutral rate of interest' (r*) is best defined as:
- The real short-term interest rate consistent with full employment and stable inflation in the long run (Correct answer)
- The rate at which the central bank lends to commercial banks overnight
- The average nominal yield on 10-year government bonds
- The rate of return that equates saving and investment at the global level
Correct answer: The real short-term interest rate consistent with full employment and stable inflation in the long run
The neutral rate is the theoretical equilibrium real rate where monetary policy is neither expansionary nor contractionary given an economy at potential.
Question 4: According to the expenditure approach to measuring GDP, which formula is correct?
- GDP = C + I + G + (X - M) (Correct answer)
- GDP = wages + rent + interest + profits
- GDP = national income + depreciation + statistical discrepancy
- GDP = gross output − intermediate consumption
Correct answer: GDP = C + I + G + (X - M)
The expenditure approach sums consumption (C), investment (I), government spending (G), and net exports (X−M) to arrive at GDP.
Question 5: A central bank adopting a Taylor Rule sets its policy rate based primarily on:
- Deviations of inflation from target and deviations of output from potential (Correct answer)
- The current level of the money supply and the velocity of money
- The exchange rate and the current account balance
- Unemployment alone, targeting the NAIRU directly
Correct answer: Deviations of inflation from target and deviations of output from potential
The Taylor Rule prescribes a policy rate as a function of the neutral rate plus adjustments for the inflation gap and the output (or unemployment) gap.
Question 6: Which of the following is an example of an automatic fiscal stabilizer?
- Unemployment insurance benefits that rise automatically during recessions (Correct answer)
- A legislated one-time stimulus check approved by Congress
- A central bank rate cut in response to falling GDP
- Increased government infrastructure spending passed during a downturn
Correct answer: Unemployment insurance benefits that rise automatically during recessions
Automatic stabilizers like unemployment insurance expand spending without new legislation during downturns, cushioning the economic cycle.
Question 7: The 'J-curve effect' in international economics describes:
- A trade balance that worsens immediately after currency depreciation before later improving (Correct answer)
- The pattern of economic growth following a financial crisis
- The relationship between income inequality and economic development
- Rising commodity prices that eventually stimulate domestic production
Correct answer: A trade balance that worsens immediately after currency depreciation before later improving
Short-term import prices rise faster than export volumes adjust after depreciation, initially widening the trade deficit before competitiveness gains improve it.
CFA Economic Analysis & Indicators 3
Which of the following best describes 'stagflation' and which economic framework struggled most to explain it?