Chartered Financial Analyst (CFA) Economics Syllabus

How are nominal GDP, real GDP, and the GDP deflator related?

Nominal GDP uses current prices; real GDP uses base-year prices to remove inflation. $$\text{GDP deflator} = \frac{\text{Nominal GDP}}{\text{Real GDP}} \times 100.$$

What is the relationship between saving, investment, the fiscal balance, and the trade balance?

From national accounts: $$(S - I) = (G - T) + (X - M).$$ Private saving minus investment equals the government deficit plus the trade surplus. Equivalently, the sum of private, government, and external balances must net to zero.

What distinguishes the short-run aggregate supply (SRAS) curve from the long-run aggregate supply (LRAS) curve?

SRAS is upward sloping because some input prices (especially wages) are sticky, so higher output prices raise profits and output. LRAS is vertical at potential (full-employment) GDP because in the long run all prices and wages adjust, making output independent of the price level.

What causes movements along versus shifts of the aggregate demand curve?

A change in the price level causes a movement along the AD curve via the wealth effect, interest rate effect, and real exchange-rate effect. Shifts of AD come from changes in consumption, investment, government spending, net exports, expectations, monetary policy, or fiscal policy at a given price level.

Distinguish cost-push inflation from demand-pull inflation.

Cost-push inflation arises from rising input costs (e.g., wages or commodity prices) that shift SRAS leftward, raising prices while lowering output (stagflation risk). Demand-pull inflation arises from rising aggregate demand that shifts AD rightward, raising both prices and output beyond potential.

List the inputs and the two broad ways economic growth can be achieved.

Output is produced from labor, capital, raw materials/natural resources, and technology. Growth can come from (1) increasing the quantity of inputs (labor, capital) or (2) raising total factor productivity (more output per unit of input, mainly via technology).

State the Cobb-Douglas production function and its growth accounting decomposition.

$$Y = A K^{\alpha} L^{1-\alpha},$$ where $A$ is total factor productivity and $\alpha$ is capital's output share. Growth accounting: $$\frac{\Delta Y}{Y} = \frac{\Delta A}{A} + \alpha \frac{\Delta K}{K} + (1-\alpha)\frac{\Delta L}{L}.$$

What are the four phases of the business cycle?

1) Expansion (rising output, employment, and confidence), 2) Peak (top of activity), 3) Contraction/recession (declining output and rising unemployment), 4) Trough (bottom, before recovery begins).

Compare how Keynesian, Monetarist, and Austrian schools view business cycles.

Keynesians emphasize swings in aggregate demand and advocate active fiscal/monetary intervention. Monetarists blame inappropriate growth in the money supply and favor a stable money-growth rule. Austrians attribute cycles to excessive credit/monetary expansion causing malinvestment, with recessions as necessary corrections.

Distinguish frictional, structural, and cyclical unemployment.

Frictional: short-term, from people transitioning between jobs. Structural: long-term mismatch between workers' skills/location and available jobs. Cyclical: caused by economic downturns (deficient aggregate demand). The natural rate of unemployment includes frictional and structural but not cyclical.

How are the labor force participation rate and the unemployment rate calculated?

$$\text{Unemployment rate} = \frac{\text{Unemployed}}{\text{Labor force}}.$$ $$\text{Participation rate} = \frac{\text{Labor force}}{\text{Working-age population}}.$$ The labor force = employed + actively-seeking unemployed; discouraged workers are excluded.

Distinguish a price index from a chain-weighted measure, and define headline vs. core inflation.

A Laspeyres index (like CPI) uses a fixed base-period basket and tends to overstate inflation; chain-weighting updates weights to reduce substitution bias. Headline inflation includes all goods; core inflation excludes volatile food and energy prices to better reveal the underlying trend.

What are leading, coincident, and lagging economic indicators? Give an example of each.

Leading indicators change before the economy (e.g., stock prices, building permits, new orders). Coincident indicators move with the economy (e.g., industrial production, employment). Lagging indicators change after the economy (e.g., average duration of unemployment, inventory-to-sales ratio).

What are the two main tools of fiscal policy and their objectives?

The tools are government spending and taxation. Objectives include managing aggregate demand to stabilize the economy, influencing the distribution of income and wealth, and allocating resources (e.g., providing public goods).

Distinguish automatic stabilizers from discretionary fiscal policy.

Automatic stabilizers (e.g., progressive taxes and unemployment benefits) adjust without new legislation, dampening cycles automatically. Discretionary fiscal policy requires deliberate government action to change spending or taxes.

Define the fiscal multiplier and write its formula with taxes.

The fiscal multiplier measures how much equilibrium output changes per unit change in autonomous spending: $$\text{Multiplier} = \frac{1}{1 - MPC(1 - t)},$$ where MPC is the marginal propensity to consume and $t$ is the tax rate. A higher MPC raises the multiplier.

What is the balanced-budget multiplier and what does it imply?

The balanced-budget multiplier equals 1: an equal increase in government spending and taxes raises equilibrium income by the amount of the spending increase. This is because spending injects the full amount while the tax only reduces consumption by MPC × the tax.

What is Ricardian equivalence?

The proposition that, when a government cuts taxes by issuing debt, forward-looking taxpayers anticipate higher future taxes and save the windfall to pay them. Thus the timing of taxes versus borrowing has no effect on aggregate demand and the deficit does not stimulate consumption.

Identify the main limitations/lags of fiscal policy.

Recognition lag (time to identify the problem), action/legislative lag (time to enact policy), and impact lag (time for policy to affect the economy). Other issues include crowding out of private investment, the difficulty of timing, and rising public debt.

State the equation of exchange and the quantity theory of money.

$$M \times V = P \times Y,$$ where $M$ is money supply, $V$ is velocity, $P$ is the price level, and $Y$ is real output. The quantity theory holds that with $V$ and $Y$ stable, changes in $M$ translate directly into proportional changes in $P$.

What is the money multiplier and its formula with a reserve requirement?

The money multiplier is the maximum amount the money supply can expand per unit of new reserves: $$\text{Money multiplier} = \frac{1}{r},$$ where $r$ is the required reserve ratio. For example, $r = 0.10$ gives a multiplier of $10$.

List the three main tools central banks use to conduct monetary policy.

1) Open market operations (buying/selling government securities), 2) the policy rate (e.g., the discount or refinancing rate), and 3) reserve requirements. Open market operations are typically the most frequently used tool.

What is the Fisher relation linking nominal and real interest rates?

$$R_{nominal} \approx R_{real} + \pi^{e},$$ where $\pi^{e}$ is expected inflation. More precisely, $(1 + R_{nominal}) = (1 + R_{real})(1 + \pi^{e})$. The nominal rate also includes a risk premium for uncertainty about inflation in practice.

What three qualities must a central bank possess to conduct effective monetary policy?

Independence (free from political interference), credibility (markets believe it will follow through on targets), and transparency (clear communication of objectives and reasoning, e.g., through published inflation targets).

What is the Taylor rule and what does it prescribe?

$$R_{target} = R_{neutral} + \pi + 0.5(\pi - \pi^{*}) + 0.5(Y_{gap}),$$ where $\pi^{*}$ is target inflation and $Y_{gap}$ is the percentage output gap. It prescribes raising the policy rate when inflation is above target or output is above potential, and lowering it otherwise.

Define the neutral (equilibrium) policy rate and contrast contractionary with expansionary monetary policy.

The neutral rate neither stimulates nor restrains the economy (real neutral rate ≈ trend real GDP growth). A policy rate above neutral is contractionary (slows demand to fight inflation); a rate below neutral is expansionary (boosts demand to fight recession).

What is a liquidity trap and why does it weaken monetary policy?

A liquidity trap occurs when interest rates are near zero and people hold cash rather than bonds, so additional money injections fail to lower rates further or stimulate spending. Conventional monetary policy becomes ineffective, often prompting quantitative easing or fiscal action.

What are the main motives and tools governments use for trade restriction, and name common trade barriers.

Motives include protecting infant industries, national security, retaliation, and protecting domestic jobs. Tools/barriers include tariffs (taxes on imports), quotas (quantity limits), voluntary export restraints, export subsidies, and minimum domestic content requirements.

Compare absolute advantage and comparative advantage.

Absolute advantage: a country can produce a good using fewer resources than another. Comparative advantage: a country can produce a good at a lower opportunity cost than another. Gains from trade arise from comparative advantage even if one country has absolute advantage in all goods.

Contrast the Ricardian and Heckscher-Ohlin models of comparative advantage.

The Ricardian model attributes comparative advantage to differences in labor productivity (technology). The Heckscher-Ohlin model attributes it to differences in factor endowments—countries export goods that intensively use their relatively abundant factor (labor or capital).

Distinguish the balance of payments accounts: current, capital, and financial.

Current account: trade in goods/services, net income, and transfers. Capital account: capital transfers and acquisition/disposal of non-produced, non-financial assets. Financial account: cross-border investment in financial assets/liabilities. By construction the accounts sum to zero (offsetting flows).

Define a spot exchange rate quote and explain direct vs. indirect quotes.

A spot rate is the price for immediate currency exchange, quoted as price currency per unit of base currency (base:price). A direct quote gives the domestic currency price of one unit of foreign currency; an indirect quote gives the foreign currency price of one unit of domestic currency (the reciprocal).

How do you compute a forward premium or discount and a cross rate?

Forward premium/discount (in points) $= F - S$; in percent $= \frac{F - S}{S}$. A positive value means the base currency trades at a forward premium. A cross rate combines two quotes through a common currency, e.g., $\frac{A}{C} = \frac{A}{B} \times \frac{B}{C}$.

State covered interest rate parity (CIRP).

CIRP is a no-arbitrage condition relating spot and forward rates to interest rate differentials: $$F = S \times \frac{1 + i_{price}}{1 + i_{base}},$$ where $i$ are the period interest rates of the price and base currencies. The currency with the higher interest rate trades at a forward discount.

State uncovered interest rate parity (UIRP) and how it differs from CIRP.

UIRP holds that the expected change in the spot rate equals the interest rate differential: the higher-yielding currency is expected to depreciate by approximately the interest differential. Unlike CIRP, UIRP uses the expected future spot rate (not the forward rate) and is not enforced by arbitrage, so it often fails empirically.

State absolute and relative purchasing power parity (PPP).

Absolute PPP: identical goods baskets have the same price across countries when expressed in a common currency (law of one price). Relative PPP: the expected change in the exchange rate equals the inflation differential, $$\% \Delta S \approx \pi_{base} - \pi_{price}.$$

What does the international Fisher effect state?

The international Fisher effect holds that the nominal interest rate differential between two countries equals the expected inflation differential (assuming equal real rates). Thus the currency of the higher-interest-rate country is expected to depreciate by the inflation/interest differential.

Compare the mechanisms of the Mundell-Fleming, monetary, and portfolio balance models for exchange-rate determination.

Mundell-Fleming: focuses on how monetary/fiscal policy affects interest rates and trade flows to move exchange rates (incorporating capital mobility). Monetary approach: exchange rates driven by relative money supplies and price levels (PPP-based). Portfolio balance: long-run model where investors' relative demand for countries' bonds (and fiscal sustainability) drives rates.

How does a country's exchange rate regime range from fixed to floating?

From most rigid to most flexible: formal dollarization/currency union (no own currency), currency board, conventional fixed peg, crawling peg/bands, managed float, and independent (free) float. Greater flexibility gives more monetary policy independence but less exchange-rate stability.

What is the impossible trinity (trilemma) of international finance?

A country cannot simultaneously have all three of: (1) a fixed exchange rate, (2) free capital movement, and (3) an independent monetary policy. It must give up one—e.g., a fixed rate with open capital flows means surrendering monetary autonomy.

Distinguish classical, neoclassical, and endogenous growth theories.

Classical (Malthusian): growth is temporary because population growth drives per-capita income back to subsistence. Neoclassical (Solow): growth converges to a steady state determined by exogenous technology; capital alone has diminishing returns. Endogenous: technological progress is determined within the model (via R&D and human capital), so policy can permanently raise the growth rate.

In the neoclassical (Solow) model, what determines the long-run sustainable growth rate of output per capita?

Only the rate of technological progress (growth in total factor productivity) determines long-run growth in output per capita. Capital deepening raises output temporarily but faces diminishing returns, so saving/investment rates affect the level of income but not the steady-state growth rate.

What is convergence in growth theory, and distinguish absolute from conditional convergence?

Convergence is the tendency for poorer countries to grow faster and catch up to richer ones. Absolute convergence: all countries converge to the same income level. Conditional convergence: countries converge only to their own steady state determined by their savings rate, population growth, and institutions. Club convergence: only countries with similar characteristics converge.

What are the major preconditions/sources of sustainable economic growth?

Key drivers include savings and investment in physical capital, investment in human capital (education), development of financial markets, sound institutions and property rights, political stability, free trade and capital flows, and technological progress/R&D.

What is the difference between independent (autonomous) and self-regulating regulators, and statutory vs. self-regulating bodies?

Independent regulators are government agencies operating autonomously. Self-regulating organizations (SROs) are private, member-funded bodies that regulate their own members. An SRO granted government recognition with enforcement authority becomes an independent regulator; a non-recognized SRO has authority only over its members.

What economic rationales justify regulation, and what are the main classifications of regulation?

Rationales include addressing market failures—externalities, public goods, asymmetric information, and market power (monopoly). Classifications: (1) statutory law vs. administrative regulations vs. judicial law, and functionally (2) regulation of commerce, (3) regulation of securities/financial markets, and (4) prudential (systemic stability) regulation.

How should the costs and benefits of regulation be assessed, including regulatory burden?

Analysts weigh regulatory benefits against costs, including the regulatory burden—the private costs of compliance (sometimes net of government implementation costs). Net regulatory burden = private compliance costs minus private benefits. Because these are hard to measure ex ante, regulators often assess them after implementation, and unintended consequences (e.g., regulatory capture or arbitrage) must be considered.