Reading 23: Capital Market Expectations－LOS e policy, impact, business

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CFA Institute Area 6: Economics
Session 6: Economic Concepts for Asset Valuation in Portfolio Management
Reading 23: Capital Market Expectations
LOS e: Discuss the inventory and business cycles and the impact of consumer and business spending plus monetary and fiscal policy on the business cycle.

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Suppose that Government A decreased the tariff on foreign goods and that Government B has moved to a lower marginal tax rate. Analyzing the effects on the long-term growth rate in the economy, which of the following would be most accurate?

A) Government As growth rate will decrease and Government Bs growth rate will increase.

B) Government As growth rate will increase and Government Bs growth rate will increase.

C) Government As growth rate will decrease and Government Bs growth rate will decrease.

D) Government As growth rate will increase and Government Bs growth rate will decrease.

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Answer and Explanation

If the government decreases the tariff on foreign goods, competition should increase, increasing economic efficiency, and the long-term growth rate. The same is true of a cut in the tax rate (i.e., the long-term growth should increase).

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Which of the following regarding the use of monetary policy to stimulate growth or rein in inflation in an economy is most accurate?

A) Neither the direction of a change in interest rates nor the level of interest rates are important.

B) Both the direction of a change in interest rates and the level of interest rates are important.

C) Only the direction of a change in interest rates is important.

D) Only the level of interest rates is important.

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Answer and Explanation

Both the direction of a change in interest rates and the level of interest rates are important. If, for example, rates are increased to say 4% to combat inflation but this is still low compared to the neutral rate of 6% in a country, then this rate may still be low enough to allow growth and inflation to continue.

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Which of the following would indicate the greatest stimulation of economic growth?

A) Tax receipts increase due to a new government policy.

B) Tax receipts increase due to changes in the economy.

C) Tax receipts decline due to changes in the economy.

D) Tax receipts decline due to a new government policy.

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Answer and Explanation

Only changes in the deficit directed by government policy will influence growth. A tax cut, which would result in lower tax receipts over the short-term, would stimulate the economy. Changes in the deficit that occur naturally over the course of the business cycle are not stimulative or restrictive. In an expanding economy, deficits will decline because tax receipts increase and disbursements to the unemployed decrease. The opposite occurs during a recession.

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If inflation is targeted at 3%, exports are expected to rise by 5%, consumer spending is expected to increase at 1% and real GDP growth is expected at 2%, what would be the neutral interest rate in the economy?

A) 5%.

B) 10%.

C) 11%.

D) 3%.

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Answer and Explanation

The equilibrium interest rate in a country (the rate at which a balance between growth and inflation is achieved) is referred to as the neutral rate. It is generally thought that the neutral rate is composed of an inflation component and a real growth component. If inflation is targeted at 3% and the economy is expected to grow by 2%, then the neutral rate would be 5%. Exports and consumer spending are components of GDP and are thus already figured into the 2% GDP growth.