Chartered Financial Analyst (CFA) Economics Flashcards

24 sample cards from the Economics deck

Sampled from the end of the deck, so these are different cards from the ones shown on the syllabus page.

1. 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).

2. 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.

3. 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).

4. 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.

5. 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.

6. 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.

7. 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).

8. 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).

9. 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).

10. 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., $\frac{A}{C} = \frac{A}{B} \times \frac{B}{C}$.

11. 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.

12. 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.

13. 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, $$\% \Delta S \approx \pi_{base} - \pi_{price}.$$

14. 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.

15. 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.

16. 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.

17. 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.

18. 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.

19. 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.

20. 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.

21. 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.

22. 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.

23. 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.

24. 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.

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