Economics. 14 question(s) in this unit's pool
(2 above the exam). Free up to ten a day; the coach picks which ones based on what you have
already answered and when each is next due.
Pick an answer, say how sure you are, then reveal. Every wrong choice gets its own
explanation. Questions you have already answered correctly and confidently stay out of the way until they
are due for review again.
Question 1Exam level
During which phase of the business cycle would an analyst most likely observe declining inventory-to-sales ratios and rising capacity utilization?
How sure are you?
Correct: B. During expansion, demand is rising faster than inventory can be replenished, so the inventory-to-sales ratio falls. Capacity utilization rises as firms run plants closer to full capacity to meet demand. At the trough, inventories are excessive relative to weak sales, and capacity utilization is at its lowest.
A. Trough. You might confuse the trough (where cycle bottoms) with the early expansion. At the trough, inventory-to-sales ratios are ELEVATED and capacity utilization is at its LOW. The opposite of what the question describes.
C. Choosing peak might seem logical if you think high demand and capacity use define the end of an expansion, but at the peak, inventory-to-sales ratios typically start to rise as production struggles to meet demand, contradicting the observed falling ratios during expansion.
Unit: understanding-business-cycles
Question 2Exam level
Which of the following is LEAST likely classified as a lagging indicator of the business cycle?
How sure are you?
Correct: C. The yield spread between 10-year Treasuries and the federal funds rate is a LEADING indicator (it's one of the Conference Board's 10 LEI components). Banks only raise the prime rate AFTER the economy has already been expanding or is clearly in contraction. This confirming what already happened. Commercial loan growth peaks after economic expansion is underway. Unemployment duration peaks after the recession has already deepened.
A. You might be tempted to think that outstanding commercial and industrial loans indicate future economic activity, but this measure actually peaks after economic growth has already begun, making it a lagging indicator, unlike the yield spread which anticipates economic changes.
B. Average duration of unemployment. You might think unemployment is a leading indicator (it rises when recession is feared). The LEVEL of unemployment is lagging; the INITIAL CLAIMS for unemployment insurance is a leading indicator.
Unit: understanding-business-cycles
Question 3Harder
An economist notes that headline CPI is accelerating while real GDP growth is decelerating. This combination is MOST consistent with which business cycle phase?
How sure are you?
Correct: A. Inflation is a lagging indicator. It continues rising after growth peaks because supply chain pricing, wage contracts, and commodity prices carry momentum. GDP decelerating while CPI accelerates is the classic early contraction signature, sometimes producing 'stagflation-lite.' This is why the CFA curriculum warns that CPI peaking AFTER GDP peaks. Candidates who assume inflation falls with GDP will be wrong on timing questions.
B. Mid-expansion. In mid-expansion, both GDP and inflation are rising together. The question describes divergence, which is characteristic of the phase transition at the peak.
C. Choosing the trough phase might seem logical if you associate economic recovery with rising inflation, but at the trough, both GDP and CPI typically bottom out together, not showing the inflation acceleration you see with decelerating GDP growth as in the peak transitioning to contraction phase.
Unit: understanding-business-cycles
Question 4Exam level
According to the technical definition of a recession most commonly used in economics, a recession is most likely described as:
How sure are you?
Correct: B. The CFA curriculum defines recession using the technical definition: two or more consecutive quarters of negative real GDP growth. This is distinct from the NBER definition, which uses a broader set of indicators and does not require two consecutive negative GDP quarters. The CFA exam tests BOTH definitions and expects candidates to know the distinction.
A. NBER definition. While technically accurate for the U.S., the CFA curriculum presents the 'two consecutive quarters of negative real GDP' as the standard technical definition. Candidates who confuse the two definitions select A and miss the question.
C. You might be tempted by choice C if you associate significant GDP declines with recessions, but a single quarter of more than 2% decline does not define a recession according to the technical definition; it requires two consecutive quarters of negative real GDP growth to qualify.
Unit: understanding-business-cycles
Question 5Exam level
An investment strategist believes the economy is at a trough and about to enter early expansion. Which of the following portfolio tilts is MOST consistent with this view?
How sure are you?
Correct: B. At the trough/early expansion, cyclical equities (consumer discretionary, industrials, materials) outperform because they have the most operating leverage to benefit from recovering demand. Commodities begin to rally as industrial production recovers. Long-duration bonds are UNDERWEIGHT because interest rates are likely to rise from trough levels as the economy recovers, hurting bond prices. Cash is appropriate at late contraction, not early expansion. That's when you deploy it into risk assets.
A. Cyclical equities and long-duration bonds. This is the most common mistake: candidates correctly identify cyclical equities but incorrectly add long bonds. Long bonds perform best during CONTRACTION (falling rates), not at the trough when rates are set to rise.
C. Choosing C might seem logical if you are thinking about preserving capital in uncertain times, but this approach underweights equities at a time when cyclical equities are poised to benefit from economic recovery, contrary to the strategy of overweighting equities and commodities during early expansion.
Unit: understanding-business-cycles
Question 6Exam level
According to Austrian business cycle theory, the primary cause of business cycle booms and busts is most likely described as:
How sure are you?
Correct: B. Austrian theory (Mises-Hayek) holds that central bank credit expansion artificially suppresses interest rates below their natural rate, causing entrepreneurs to undertake capital-intensive projects that would not be profitable at natural rates. So-called 'malinvestments.' When rates normalize, these projects become unprofitable, causing the bust.
A. Animal spirits. You might associate boom-bust with behavioral finance and select A. Keynes coined 'animal spirits' for investment volatility, but Austrian theory is mechanistic: it blames the credit expansion mechanism, not irrationality.
C. Choosing C might be tempting if you associate external shocks with causing economic fluctuations, but Austrian business cycle theory specifically attributes booms and busts to monetary policy actions rather than supply-side disruptions.
Unit: understanding-business-cycles
Question 7Harder
The inventory cycle (Kitchin cycle) is MOST accurately characterized as:
How sure are you?
Correct: B. The Kitchin cycle (inventory cycle) runs approximately 3-5 years and is driven by business inventory adjustments. When firms over-accumulate inventory (misreading demand signals), they cut orders sharply, causing a mini-contraction. The 7-11 year cycle is the Juglar cycle (business fixed investment). The 15-25 year cycle is the Kuznets cycle (construction/real estate). The 40-60 year cycle is the Kondratiev wave (technological paradigm shifts).
A. 7-11 year cycle. You might confuse the Kitchin (inventory) and Juglar (capital equipment) cycles. The key differentiator: Kitchin is INVENTORY (short), Juglar is CAPITAL EQUIPMENT (medium).
C. You might be tempted by choice C because it mentions technological innovation, which can significantly impact business cycles, but this choice describes the Kondratiev wave, a much longer cycle than the inventory cycle, which focuses on shorter-term inventory adjustments.
Unit: understanding-business-cycles
Question 8Exam level
Which of the following is most likely a component of the Conference Board's Leading Economic Index (LEI)?
How sure are you?
Correct: B. The ISM new orders index is a leading indicator. Manufacturers receive orders before production begins, making it forward-looking. CPI change and outstanding commercial loans are LAGGING indicators. Average duration of unemployment is also LAGGING (it peaks long after recession ends, as long-term unemployed remain jobless). The 10 Conference Board LEI components include: average weekly manufacturing hours, initial jobless claims (inverted), new orders for consumer goods, ISM new orders index, building permits, stock prices (S&P 500), Leading Credit Index, interest rate spread (10-yr Treasury minus fed funds), average consumer expectations.
A. CPI change. You might remember that inflation is important and assume it leads. Inflation is actually LAGGING. Prices take time to adjust to demand conditions already present in the economy.
C. You might think outstanding commercial and industrial loans indicate economic growth, but this measure reflects past borrowing activity and is a lagging indicator, unlike the ISM new orders index which forecasts future manufacturing activity.
Unit: understanding-business-cycles
Question 9Exam level
Which combination of characteristics most likely accurately describes the peak phase of the business cycle?
How sure are you?
Correct: A. At the peak: employment is maximal (unemployment at cycle low. A LAGGING indicator that only reaches its minimum at or just past the peak), inflation is at or approaching its high (lagging, continuing to rise), and credit conditions are tightening as central banks raise rates to combat inflation. Choice B describes mid-expansion. Choice C describes mid-contraction.
B. Unemployment rising rapidly at peak. The peak is where cycle turns. Unemployment is still LOW at the peak (it lags). It rises DURING the subsequent contraction. You might confuse the peak with the early contraction.
C. You might be tempted by choice C if you confuse the peak phase with the trough phase, where unemployment is indeed at its highest and inflation at its lowest. However, during the peak phase, unemployment is at its lowest and inflation is rising, not the opposite as choice C suggests.
Unit: understanding-business-cycles
Question 10Harder
During the contraction phase of a credit cycle, which of the following investment outcomes is MOST likely?
How sure are you?
Correct: B. In a credit contraction, risk aversion rises sharply. Investors flee to safety. Government bonds rally (prices rise, yields fall). High-yield corporate bonds are sold as default risk perceptions spike, causing spreads to widen dramatically. Commodity prices typically FALL in credit contraction (demand collapses). Equity volatility RISES (VIX spikes). Bank lending standards TIGHTEN. This is the core flight-to-quality mechanism.
A. Credit spreads narrow and equity rises. This describes credit expansion (boom). Candidates who mix up cycle direction get this wrong. The question says CONTRACTION. Everything risk-on falls.
C. You might read a credit contraction as a calming period where volatility settles and banks relax their standards, since fewer new loans are being made. The opposite happens: rising default risk pushes implied volatility up as investors bid for protection, and banks tighten lending standards to protect themselves from those same rising defaults. Falling volatility and easing credit describe a credit expansion, not a contraction.
Unit: understanding-business-cycles
Question 11Exam level
A Keynesian economist and a Neoclassical economist are debating the cause of a prolonged economic contraction. The Keynesian economist would MOST likely argue that:
How sure are you?
Correct: B. Keynesian theory holds that market economies can get trapped in equilibria below full employment due to deficient aggregate demand. Wages and prices are 'sticky' downward, preventing rapid self-correction. The policy prescription is fiscal stimulus (government spending/tax cuts). Choice A-B reflect Neoclassical/real business cycle views (markets clear efficiently).
A. Choosing A might tempt you if you confuse the Keynesian view with the Neoclassical perspective, where flexible prices and wages naturally correct economic downturns; however, Keynesian economics specifically argues that prices and wages are sticky, requiring fiscal intervention to boost aggregate demand and restore full employment.
C. Austrian theory. Candidates who haven't memorized the theory distinctions mix up Austrian (credit-driven malinvestments) with Keynesian. The key Keynesian identifier is 'aggregate demand deficiency' and 'sticky prices/wages.'
Unit: understanding-business-cycles
Question 12Harder
A portfolio manager using a business cycle sector rotation strategy would MOST likely shift toward which sectors during the late expansion phase?
How sure are you?
Correct: A. In late expansion, the economy is running near full capacity. Commodity prices spike as supply constraints emerge. Energy and materials companies benefit from price increases with relatively fixed costs, expanding margins dramatically. Consumer discretionary and technology peak in MID-expansion (already fully priced in). Utilities and consumer staples are DEFENSIVE. They outperform during contraction. The rotation sequence: early expansion = financials + consumer discretionary; mid-expansion = tech + industrials; late expansion = energy + materials; contraction = defensive (utilities, healthcare, staples); trough = financials again.
B. Consumer discretionary and technology. These sectors lead in EARLY-to-MID expansion, not late expansion. By late expansion, their valuations are stretched and growth is priced in. Candidates who know 'cyclicals outperform in expansion' without knowing the WITHIN-expansion rotation miss this distinction.
C. You might be tempted by healthcare and industrials because these sectors often show stability and growth, but during late expansion, the focus shifts to sectors benefiting from high commodity prices, making energy and materials more attractive as they capitalize on rising costs and fixed expenses.
Unit: understanding-business-cycles
Question 13Above the exam
An economist observes that the index of leading economic indicators has declined for three consecutive months while the unemployment rate (a lagging indicator) is still falling. Combining the definitions of leading and lagging indicators with the typical sequencing of a business cycle, the most likely correct interpretation is that:
How sure are you?
Correct: B. Leading indicators change direction BEFORE the overall economy does, so a declining leading index is an early warning of a coming slowdown. The unemployment rate is a LAGGING indicator, meaning it continues reflecting past strength (still falling, i.e. improving) even after the broader economy has started to turn; lagging indicators are expected to keep moving in the old direction for a while after a leading indicator has already reversed. The two signals are not contradictory, they are exactly what the leading/lagging framework predicts at a turning point.
A. Unemployment is a LAGGING indicator by design; it reflects conditions from months ago, not current or future momentum. Reading a lagging indicator as proof of ongoing acceleration ignores that its whole purpose is to confirm turns only after they have already begun.
C. The two signals are not contradictory once their different roles are understood: leading indicators are supposed to move first, lagging indicators are supposed to move last, so a declining leading index alongside a still-improving lagging indicator is the textbook pattern near a cyclical peak, not a conflict.
Unit: understanding-business-cycles
Question 14Above the exam
During the contraction phase of a business cycle, inventory-to-sales ratios are observed to be rising even though firms are actively cutting production. Combining the definition of involuntary inventory accumulation with the typical business-cycle sequence, this pattern most likely indicates:
How sure are you?
Correct: B. Early in a contraction, demand (sales) typically falls faster than firms can adjust production downward, since production plans and supply chains cannot be cut instantaneously. The result is involuntary inventory buildup: goods that were produced under earlier, more optimistic sales expectations go unsold, pushing inventory-to-sales ratios up even while firms are actively reducing output. This is a classic contraction signature, not a sign of deliberate stockpiling or recovery.
A. Deliberate inventory building in anticipation of recovery would typically accompany rising or stable production, not active production cuts; the fact pattern describes firms cutting output while inventory still rises, which points to involuntary accumulation from falling sales, not a deliberate strategic buildup.
C. Rising inventory-to-sales ratios alongside falling production is a hallmark of the contraction phase itself, not the trough or early recovery; recovery is typically associated with inventory-to-sales ratios beginning to FALL as sales pick back up relative to stock on hand.