Analysis: Economic Analysis

Which of the following is a lagging economic indicator? Personal Income Commercial Loans Outstanding Building Permits Contracts for Plant and Equipment

Commercial Loans Outstanding Commercial loans outstanding is a lagging indicator, since it shows what was already borrowed (and presumably spent). Personal income levels is a coincident indicator. Both building permits and contracts for plant and equipment are leading indicators, showing production that will occur in the near future.

Which of the following is a leading economic indicator? Personal Income Employment Duration Labor Cost Per Manufactured Unit Contracts for plant and equipment

Contracts for plant and equipment Contracts for plant and equipment are a leading indicator, since these must be built or produced over the coming months. Personal income levels is a coincident indicator, showing current earnings for consumers. Both employment duration (how long the average person worked before being terminated) and labor cost per manufactured unit are lagging indicators, since they show what has already happened.

In a period of deflation, which of the following statements about issuers of fixed income securities are TRUE? I Issuers are more likely to sell fixed income securities II Issuers are less likely to sell fixed income securities III Issuers are likely to sell non-callable issues IV Issuers are likely to sell callable issue

I Issuers are more likely to sell fixed income securities III Issuers are likely to sell non-callable issues In a deflationary period, prices fall. Therefore, money buys "more" in real terms. As deflation occurs, interest rates will drop, causing long term debt prices to rise. Because interest rates will be lower, issuers are more likely to sell fixed income securities - it costs them less to finance. Issuers are likely to sell non-callable issues because interest rates are low, and there is no need to call in such issues when the financing rates are so favorable. Callable issues are generally sold in periods of high interest rates, so the issuer can call in the securities if interest rates fall subsequently.

Which of the following are terms that describe economic indicators? I Leading II Lagging III Coincident IV Concomitant

I Leading II Lagging III Coincident Economic indicators either lag the economy; lead the economy; or are coincident with the economy. There is no such terminology as a concomitant indicator.

The Federal Reserve open market tradingactivities affect which of the following? I M 1 levels II GDP growth III Treasury's accounts IV National debt levels

I M 1 levels II GDP growth III Treasury's accounts Open market operations do not affect the national debt. The issuance and redemption of government securities by the Treasury determines the national debt level. Open market operations affect monetary levels such as M1 (currency in circulation and demand deposits); affect the business cycle; and affect the Treasury's accounts, since FRB funding for its trading activities is provided through the Treasury.

Which of the following actions by the Federal Reserve will lower interest rates? I Purchases of securities as directed by the FOMC II Sales of securities as directed by the FOMC III Repurchase agreements with U.S. Government dealers and banks IV Reverse repurchase agreements with U.S. Government dealers and banks

I Purchases of securities as directed by the FOMC III Repurchase agreements with U.S. Government dealers and banks To lower interest rates, the Federal Open Market Committee must direct a loosening of the money supply. Purchases of securities by the Fed injects cash to the dealers, and loosens available credit (more money is available to be lent out). In a repurchase agreement, the Fed buys government securities from the bank dealers, thus injecting cash into the bank dealers - who can now lend out more.

Which statements are TRUE? I Fiscal Policy is set by Congress II Fiscal Policy is set by the Federal Reserve III Monetary Policy is set by Congress IV Monetary Policy is set by the Federal Reserve

I Fiscal Policy is set by Congress IV Monetary Policy is set by the Federal Reserve Congress sets Fiscal Policy (e.g., tax rates, social program spending, defense spending, etc.) The Federal Reserve sets Monetary Policy.

Which economic theory postulates that production and economic growth are stimulated by lower interest rate levels, and can be managed by Federal Reserve actions?

Monetarist Theory Monetarist Theory states that economic growth is controlled by the Federal Reserve's actions. If the Federal Reserve allows the money supply to grow at a pace consistent with real economic growth, there is balance. The theory holds that if the Federal Reserve allows the money supply to grow more rapidly than real economic growth, interest rates will fall, stimulating borrowing and investment. Conversely, if the Federal Reserve allows the money supply to grow more slowly than real economic growth, interest rates will rise, reducing borrowing and investment.

The interest rate charged from commercial banks to their best customers is the:

Prime rate The lowest rate is the Federal Funds Rate. This is the rate on overnight loans of reserves from bank to bank. The next highest rate is the Discount Rate. This is the rate that the Federal Reserve charges member banks for borrowing reserves from the Fed. The next highest rate is the Broker Loan Rate. This is the rate that brokerage firms can borrow from banks using securities as collateral. The highest rate is the Prime Rate. This is the rate for unsecured borrowing from banks by the best corporate customers.

A six month mild decline in economic activity is a(n):

Recession A recession is a decline in Gross Domestic Product for 2 consecutive quarters or more.

Which of the following is a lagging economic indicator? Index of Industrial Production Reported corporate profits Standard and Poor's 500 Index New consumer goods orders

Reported corporate profits Reported corporate profits are a lagging indicator because they show activity for the prior quarter. The index of industrial production is a coincident indicator, showing output levels at that time. Both new consumer goods orders and the Standard and Poor's 500 Index are leading indicators.

The use of which tool of the Federal Reserve has the biggest impact on money supply levels?

Reserve requirements Monetary policy tools of the Fed include setting reserve requirements, open market operations, setting the discount rate, and setting margin rates on securities. Changing reserve requirements has the largest impact on money supply levels, due to the effect of the "money multiplier." Because only a small percentage of deposits are retained on reserve, the amount that is lent out by the bank "multiplies out" as it is deposited to another bank, which retains a portion and lends out the balance, which is deposited to another bank, which retains a portion and lends out the balance, etc. Changing the reserve requirement would have an enormous expansionary or contractionary effect on money supply levels - hence this tool of the Federal Reserve is almost never changed.

The broadest measure of the money supply is:

The broadest measure of the money supply is "L." L consists of M-3 plus money market instruments and government savings bonds. Note that the Federal Reserve no longer computes M-3 or L, but these may still be tested.

rates from lowest to highest:

The lowest rate is the Federal Funds Rate. This is the rate on overnight loans of reserves from bank to bank. The next highest rate is the Discount Rate. This is the rate that the Federal Reserve charges member banks for borrowing reserves from the Fed. The next highest rate is the Broker Loan Rate. This is the rate that brokerage firms can borrow from banks using securities as collateral. The highest rate is the Prime Rate. This is the rate for unsecured borrowing from banks by the best corporate customers.

M3:

a broader measure of the money supply than M2 (currency in circulation and checkable deposits and time deposits of less than $100,000), M3 equals M2 plus time deposits of more than $100,000.

Recession:

a decline in Gross Domestic Product (or Gross National Product) for two consecutive quarters.

Depression:

a decline in the Gross Domestic Product (or Gross National Product) for 18 consecutive months.

Yield curve:

a graph, with a vertical axis depicting the yield and a horizontal axis representing years to maturity, that depicts the yields of bonds with similar quality but different maturities. The shape of the yield curve can be ascending (normal), descending, flat, or humped. The shape is dependent on investor expectations for future interest rate levels, actions of the Federal Reserve to tighten or loosen credit, and the supply and demand for debt issues in each maturity segment of the curve.

Consumer Confidence Index:

a leading economic indicator published by the Conference Board measuring consumer confidence levels, and hence, likely future consumer spending levels.

Help Wanted Advertising Index:

a leading economic indicator published by the Conference Board that surveys the level of help wanted advertising in newspapers across the country - a high level indicates future employment gains and hence, greater economic output.

M1:

a measure of the money supply, this is cash in circulation and demand (checkable) deposits.

Overnight repo:

a repurchase agreement in which the selling party agrees to repurchase the securities the next day. This is the most common duration of a repurchase agreement.

Gross domestic product:

abbreviated GDP, this is the total market value of goods and services produced in the United States in a year, excluding the value of production by U.S. owned overseas operations.

Gross National Product:

abbreviated GNP, which is the sum of all goods and services produced by the U.S. economy in a year. GNP not only includes U.S. based production, but also includes the value of production by U.S. owned overseas operations.

Monetary policy:

actions taken by the Federal Reserve Board (FRB) to loosen or tighten the money supply. These actions include engaging in open market operations, changing the discount rate, changing the reserve requirement, changing margin requirements, and moral suasion. (

Fiscal policy:

actions taken by the federal government, and approved by Congress, to increase business activity and the growth of the economy. These actions include changing federal income tax rates, changing transfer payments (Social Security), and changing the way the government spends money for goods and services.

The Gross Domestic Product includes: I Consumer Expenditures II Government Expenditures III Fixed Investment

all Gross domestic product is the entire output of the U.S. economy. It includes individual consumption, government spending, and fixed investment.

Coincident economic indicator:

an economic measure that indicates the economy's current position in the business cycle. Gross National Product (GNP), personal income, and the index of industrial production are among the coincident indicators.

Lagging economic indicator:

an economic measure that shows where the economy was in the business cycle during the past 12 months. Lagging indicators include reported corporate profits, the ratio of consumer credit to income levels, and employment duration

Keynesian theory:

an economic theory postulated by John Maynard Keynes that the level of economic growth is determined by the level of fiscal stimulus provided by the government.

Monetarist theory:

an economic theory postulated by Milton Friedman that the level of economic growth is determined by monetary policy, that is, the actions the Federal Reserve Board

Supply-side theory:

an economic theory, popularly known as Reaganomics since it came into use during the Reagan administration, that is a mirror image of Keynesian theory. It postulates that reducing fiscal stimulus (reduction of government spending) and reducing taxes will give entrepreneurial individuals the incentive to form businesses, resulting in an expanding economy

Federal funds:

an overnight, unsecured loan between bank members of the Federal Reserve System, this is the shortest term money market instrument. The loan is made from a Federal Reserve member bank that has excess reserves to a member bank that is deficient in reserves monies payable the same day at a member bank of the Federal Reserve System. Trades of U.S. Government and Agency securities settle next business day in Federal funds.

During prolonged periods of economic expansion, interest rates can be expected to:

increase During prolonged periods of economic expansion, interest rates rise. This occurs because the Federal Reserve tightens credit to keep the economy from growing too fast; and because demand for loans rises as business activity rises.

Keynesian Theory states that the economy is stimulated by: the actions of the Federal Reserve increased Government spending decreased Government spending lowered tax rates

increased Government spending Keynesian Economic Theory states that economic growth is controlled by government spending and transfer payments (e.g., Social Security). This theory gained adherents in the 1930s during the Great Depression. With the private economy shattered at that time, the only way out was to have the government employ workers in large projects. This increased Government spending; and helped to stimulate economic activity as earnings were placed in individual pockets.

Federal funds rate:

the interest rate charged on borrowings between Federal Reserve System member banks for overnight loans of reserves. Because this rate changes daily in response to the need for borrowing, it is considered an indicator of future interest rate changes. Also note that this is the lowest interest rate in the economy

Discount rate:

the interest rate which the Federal Reserve charges member banks for making direct loans of reserves. This rate is typically set at 50 basis points (.50%) higher than the Fed Funds rate. Making changes to the discount rate is a monetary policy tool employed by the Fed to tighten or loosen the money supply.

Reserve requirement:

the percentage of demand deposits and time deposits that the Federal Reserve requires every member bank to keep on deposit in its own vault or in the vaults of one of the Fed's regional banks. Each member bank must compute its reserve every Wednesday and report it to the Fed. If a bank finds itself below the requirement, it must borrow money overnight in the Federal Funds market to temporarily meet the requirement.

Margin Requirement:

the percentage of the purchase price of a security that must be deposited to buy (or sell short) on credit. Regulation T of the Federal Reserve Board sets initial margins at 50% for both long and short stock positions.

Prime rate:

the short-term interest rate that commercial banks charge their most credit-worthy business customers.

Reverse repurchase agreement:

this is where the Federal Reserve sells U.S. Government and other eligible securities to bank dealers, with an agreement to buy back the securities, usually the next day. For 1 day, the bank dealers are drained of cash, which reduces the banks' funds that they can lend. This action tightens credit, and raises interest rates - notably the Fed funds rate.

Repurchase Agreement (Repo):

where a U.S. Government securities dealer sells securities either to the Federal Reserve or another dealer, promising to buy back the securities at a later date. The difference between the sale price and purchase price is the "interest" on the transaction. "Repos" are a source of short-term financing for dealers needing cash. When the Fed initiates a repo with a member bank dealer, it is injecting cash into the banks, expanding credit availability. Here, the government securities dealer sells securities to the fed to get liquid. As a result, interest rates are likely to drop. The duration of a repo can range from overnight to weeks.

What action is the Federal Reserve MOST likely to take if it is worried about possible deflation due to extremely rapid economic contraction? Increase the discount rate Decrease reserve requirements Decrease money velocity Increase margin requirements

Decrease reserve requirements If the Fed is worried about deflation and an economy that is contracting too rapidly, it needs to increase the available money supply and increase the level of loans being made. To do this, it could: Enter into repurchase agreements with the primary dealers (mainly large commercial banks) to given them cash, increasing loans made by banks. This would decrease the Fed Funds rate and all other interest rates in the economy; Decrease the Discount Rate (rate at which the Fed lends to member banks); Decrease Margin requirements under Regulation T (making margin borrowing more attractive); Decrease Reserve requirements, requiring banks to retain a smaller percentage of deposited funds, therefore increasing the amount that the bank can loan. Regarding money velocity, in times of recession, money velocity drops and in times of expansion, money velocity rises. To loosen credit, the Fed would want to "speed up" the money velocity, which it could do by shortening deposit clearance times - a move it almost never makes.

The Federal Reserve has been aggressively expanding the money supply by using repurchase agreements in its open market operations. Ignoring other factors, this is likely to result in:

Decreased interest rates Increased inflation If the Federal Reserve is aggressively expanding the money supply, then interest rates will drop. As the money supply is expanded, then it would be expected that as "more money" is chasing the available economic output, that prices will rise - so there should be a rise in inflation (though this happens later than the immediate drop in interest rates).

All of the following are coincident economic indicators EXCEPT: Personal Income Employment Duration Employment Levels Industrial Production

Employment Duration Coincident indicators include personal income levels, employment levels and the index of industrial production. These all show how the economy is performing at the current time. Employment duration is a lagging indicator - it shows how long someone was employed before losing their job - so it shows past history.

During which phase of the economic cycle would one most likely find monetary "inflation" starting to occur? Expansion Prosperity Recession Recovery

Expansion During the expansion phase of an economic cycle is when inflation begins to build. As output expands and there are fewer unemployed workers, pressure is put on employers for wage increases. As output expands, increased demand for goods and services also causes prices to rise. Thus, inflation tends to accelerate.

Monetary policy is set by:

Federal Reserve action Monetary policy is set by the Federal Reserve Board. The Federal Reserve can either tighten; or loosen; credit by using any of its 4 tools, which can be memorized as "DORM." D is Discount rate; O is Open Market Operations; R is Reserve Requirements; and M is Margin on securities.

Open market operations of the Federal Reserve: I cause direct changes in M1 II do not cause direct changes in M1 III influence interest rate levels IV do not influence interest rate levels

I cause direct changes in M1 III influence interest rate levels Open market operations cause direct changes in money supply levels. (M1 is the money supply measure that includes all currency in circulation and demand deposits). As the money supply expands or contracts, this influences interest rate levels in the economy.

If the Federal Reserve Open Market Committee authorizes its trading desk to enter into system wide reverse repurchase agreements, the effect will be to: I increase yields II decrease yields III raise debt prices IV lower debt prices

I increase yields IV lower debt prices If the Federal Reserve trading desk enters into reverse repurchase agreements with bank dealers, it is temporarily selling government securities to the dealers, draining them of cash. This decreases free reserves which can be loaned out by the banks. The net effect is to raise market interest rates since funds are not readily available. If interest rates rise, debt prices will fall. The Fed will take such action if it believes the economy is growing too rapidly.

If the federal funds rate has just risen to an all-time high, it means that: I the Federal Reserve is pursuing a tight money policy II the yield curve is flattening III banks may have difficulty obtaining required reserves IV long term interest rates have risen

I the Federal Reserve is pursuing a tight money policy II the yield curve is flattening III banks may have difficulty obtaining required reserves If the Federal Funds rate has risen to an all-time high, then the overnight loan rate from bank to bank is high. This means that short term rates have risen sharply, which would flatten the yield curve. This occurs when reserves are in tight supply, causing banks to have difficulty in obtaining overnight loans of reserves. The Federal Reserve tightens by entering into reverse repurchase agreements with banks, draining funds from the system temporarily. Long term rates are not directly affected by short term interest rate movements, so the statement that long term rates have risen is incorrect.

The Federal Reserve will loan funds at the discount rate to which of the following? I Savings and Loans II Commercial Banks III Investment Banks IV Insurance Companies

II Commercial Banks ONLY Only commercial banks are members of the Federal Reserve System. Member banks can borrow reserves from the Fed at the discount rate.

In a period of inflation, which of the following corporate actions is likely to occur? I Issuers are more likely to sell fixed income securities II Issuers are less likely to sell fixed income securities III If debt securities are sold, callable issues are likely IV If debt securities are sold, non-callable issues are likely

II Issuers are less likely to sell fixed income securities III If debt securities are sold, callable issues are likely In inflationary periods, interest rates rise. As interest rates rise, issuers are less likely to sell fixed income securities - it costs them more to finance. If issues are sold, issuers are likely to sell callable issues. Callable issues are generally sold in periods of high interest rates, so the issuer can call in the securities if interest rates fall subsequently.

Which of the choices given is a coincident economic indicator? Consumer Debt Levels Durable Goods Orders Index of Industrial Production Corporate Profits

Index of Industrial Production Durable goods orders are a leading economic indicator, on the assumption that the goods are yet to be produced. Thus, the economic activity associated with these orders will happen in the future. The Index of Industrial Production is a coincident indicator - it is showing economic activity at the moment. Consumer debt levels and reported corporate profits are lagging indicators. They show the results of past activity - e.g., consumers have already bought the goods on credit, thus their debt has

A decreasing Consumer Confidence Index indicates that: I consumers are confident in the overall economy II consumers are not confident in the overall economy III future spending is likely to increase IV future spending is likely to fall

II consumers are not confident in the overall economy IV future spending is likely to fall If the index is falling, then consumer confidence is low and future spending will be reduced. Conversely, an increasing index indicates that consumers are "confident," and thus are likely to spend money - resulting in increased future output.

All of the following actions taken by the Fed would increase interest rates EXCEPT: reverse repurchase agreements buying securities from government dealers draining money from the money supply raising the discount rate

buying securities from government dealers To increase interest rates, the Federal Open Market Committee must direct a tightening of the money supply. Sales of securities by the Fed drains cash from the dealers, and tightens available credit. Reverse repos by the Fed do the same thing. In a reverse repo the Fed sells government securities to the bank dealers, with an agreement to buy them back (usually the next day). For that day, the bank is drained of cash and credit is tightened. By raising the discount rate, increases in the other market rates are likely to occur as well, tightening credit. If the Fed buys securities from government dealers, it is giving the dealers cash that they can lend. This loosens credit and lowers interest rates.

FOMC:

comprised of the presidents of six Federal Reserve Banks and seven governors of the Federal Reserve, the FOMC meets about every 6 weeks and decides what monetary policy actions should be taken (if any). If the FOMC decides that credit needs to be loosened, it will direct the Federal Reserve trading desk in New York to buy U.S. Government and eligible securities from Fed member banks, thereby injecting the banks with funds. If the FOMC decides that credit needs to be tightened, it will direct the Federal Reserve trading desk in New York to sell U.S. Government and eligible securities to Fed member banks, thereby draining the banks of funds.

Gross Domestic Product is measured in: constant dollars inflated dollars dollars deflated by the gold standard dollars deflated by the sterling standard

constant dollars Gross Domestic Product is the sum of all goods and services produced in this country. To make GDP comparisons valid, GDP is measured in constant dollars, using a GDP deflator.

During the normal sequence of the economic cycle, after a period of recovery, the economy will move to a period of:

expansion The normal sequence of the economic cycle is a period of expansion, followed by an economic peak (prosperity), followed by a decline in economic activity (recession), followed by an economic recovery leading to further expansion, etc.

Rank the following interest rates from highest to lowest: I Discount Rate II Federal Funds Rate III Broker Loan Rate IV Prime Rate

high to low: IV Prime Rate III Broker Loan Rate I Discount Rate II Federal Funds Rate

A review of major newspapers across the United States reveals that "help wanted" advertisement lineage has been decreasing. This is a:

leading indicator showing that economic activity is likely to be slowing down The amount of "help wanted" advertising shows the current demand for labor. If the number of advertisements is increasing, this would show that employers plan future production. If it is decreasing, it shows that future production will be slowing. Thus it is a leading indicator, though is not included as one of the 10 leading economic indicators reported monthly. The employment indicators that are reported by the Bureau of Labor Statistics are: levels of employment, which are a coincident indicator, initial unemployment claims which are a leading indicator; and duration of employment which is a lagging indicator. Help wanted ad lineage is an indicator published by the Conference Board, in its "Help Wanted Advertising Index." (The Conference Board is an economic forecasting firm, that is mainly known for its consumer "Confidence Index.") The Help Wanted Advertising Index measures ad volumes in 51 leading newspapers in nine regions across the United States.

Clearing house funds:

monies payable upon regular way settlement of a securities transaction at a designated clearing house such as the Depository Trust and Clearing Corporation. Regular way trades of equities, corporate, and municipal bonds settle in clearing house funds, 2 business days after trade date.

The real interest rate is the:

nominal rate minus the inflation rate The "real" interest rate dials out the effect of inflation. It is the nominal interest rate minus the inflation rate.

Leading economic indicator:

one of the 10 economic measures that predict the future of the business cycle. Among the 10 are building permits, initial unemployment claims, stock prices, durable goods orders, and money supply levels.

Supply Side Theory states that: increased government spending will stimulate the economy tax rate reductions and lower government spending will stimulate the economy the actions of the Federal Reserve are the driving force behind the economy tax rate increases will stimulate the economy

tax rate reductions and lower government spending will stimulate the economy Supply Side Theory states that economic growth is controlled by individual initiative. If individuals are given the incentive to produce, they will, and the economy will grow. To give this incentive, the theory holds that government spending, and the tax collections necessary to support that government spending, should be reduced. This leaves the individual with an economic incentive to produce, since less of his or her income is being taxed.

L:

the broadest measure of the money supply, "L" includes money in all forms.

Open market operations:

the buying and selling of U.S. Government securities, and other eligible securities, in the open market by the Federal Reserve. Managed by the Federal Open Market Committee (FOMC), open market operations are a tool of monetary policy that is used every day. The Fed will sell eligible securities to member banks (draining the banks of cash) to tighten the money supply; and will buy eligible securities from member banks (injecting cash into the banks) to loosen the money supply.