CFA Level I Economics Practice Questions

Correct answer: C. Purchasing government securities in the open market

Open market operations are the tool most central banks use most frequently to implement monetary policy. Purchasing government securities injects reserves into the banking system, expanding the money supply and putting downward pressure on short-term interest rates.

• AA. Wrong. Raising reserve requirements reduces banks' lending capacity, contracting the money supply, the opposite of the stated goal.
• BB. Wrong. Selling securities withdraws reserves from the banking system, contracting the money supply, the opposite of the goal.
• CC. Correct.
• DD. Wrong. Raising the discount rate makes central-bank borrowing more expensive, a contractionary action, not an expansionary one.

• Source: Federal Reserve: Open market operations, accessed October 2026

Correct answer: B. expansionary, because the policy rate is below the estimated neutral rate of 3.8%

The neutral nominal policy rate is approximately the real trend growth rate plus the inflation target: 1.8% + 2.0% = 3.8%. A policy rate below neutral is expansionary because it is lower than the rate that neither stimulates nor restrains the economy.

• AA. Comparing the policy rate to the inflation target alone is incorrect; the real growth component must be added.
• BB. Correct. A 3.0% rate sits below the 3.8% neutral rate, so policy is expansionary.
• CC. Closeness to the inflation target does not define a neutral stance; the benchmark is the neutral rate.
• DD. Comparing the nominal policy rate with real growth alone mixes nominal and real concepts.

• Source: Exam outline: CFA Institute 2026 Level I Topic Outlines (learning outcomes), accessed October 2026

Correct answer: A. $1.133 per euro

Relative PPP predicts that the currency of the higher-inflation country depreciates by approximately the inflation differential. Here, the expected percentage change in the USD/EUR rate is approximately inflation_US minus inflation_Eurozone = 4% − 1% = 3%, so the dollar price of one euro is expected to rise (the dollar depreciates) to approximately $1.10 × 1.03 ≈ $1.133. Choice B reverses the direction, Choice C ignores the inflation differential entirely, and Choice D naively adds the raw US inflation rate without netting out Eurozone inflation.

• AA. Correct. Under relative PPP, S1 ≈ S0 × (1+i_US)/(1+i_Eurozone) = $1.10 × (1.04/1.01) ≈ $1.133; the higher-inflation currency (USD) is expected to depreciate, meaning more dollars per euro.
• BB. Incorrect. $1.067 inverts the inflation differential (dividing by the higher-inflation rate instead of the lower one), implying euro depreciation when the euro should actually appreciate.
• CC. Incorrect. An unchanged rate ignores the inflation differential entirely; relative PPP predicts the exchange rate moves to offset differing inflation rates.
• DD. Incorrect. $1.144 applies the full U.S. inflation rate without dividing by the Eurozone's inflation rate, overstating the expected depreciation.

• Source: Exam outline: CFA Institute 2026 Level I Topic Outlines (learning outcomes), accessed October 2026

Correct answer: C. the sum of the absolute price elasticities of export demand and import demand exceeds 1

The Marshall-Lerner condition states that a depreciation improves the trade balance when the sum of the absolute values of the price elasticities of export demand and import demand is greater than 1. Otherwise, price effects dominate volume effects and the trade balance can worsen.

• AA. A sum below 1 means volume responses are too weak, and the trade balance would not improve.
• BB. Inelastic import demand means the import bill rises with depreciation, which works against improvement.
• CC. Correct. The elasticity sum must exceed 1.
• DD. This is an accounting identity relating saving, investment, and the current account, not the Marshall-Lerner condition.

• Source: Exam outline: CFA Institute 2026 Level I Topic Outlines (learning outcomes), accessed October 2026

Correct answer: C. 1.235 domestic units per foreign unit

Covered interest parity gives forward = spot x (1 + domestic rate)/(1 + foreign rate) = 1.20 x 1.05/1.02, about 1.235. The higher-yielding domestic currency trades at a forward discount.

• AA. This inverts the rate ratio, which would imply the domestic currency strengthens at the forward date.
• BB. This adds the rate differential twice instead of applying the ratio of growth factors once.
• CC. Spot multiplied by 1.05/1.02 gives about 1.235 domestic units per foreign unit.
• DD. A forward equal to spot ignores the interest rate differential that parity requires to be offset.

• Source: Exam outline: CFA Institute 2026 Level I Topic Outlines (learning outcomes), accessed October 2026

Correct answer: A. $40 billion

The simple spending multiplier is 1/(1 - 0.75) = 4, so $10 billion of purchases raises aggregate demand by at most $40 billion before leakages.

• AA. A multiplier of 4 applied to $10 billion gives $40 billion as the maximum.
• BB. This divides the spending by the marginal propensity to consume instead of by one minus it.
• CC. This is the first-round consumption only, not the full multiplied effect.
• DD. This is the first-round saving, not the aggregate demand increase.

• Source: Exam outline: CFA Institute 2026 Level I Topic Outlines (learning outcomes), accessed October 2026

Correct answer: C. USD 1.235 per EUR, as the USD depreciates against the EUR because U.S. inflation exceeds euro-area inflation.

Relative PPP predicts that the currency of the higher-inflation country will depreciate by approximately the inflation differential. Forward rate (USD/EUR) ≈ Spot × (1 + US inflation)/(1 + euro-area inflation) = 1.20 × (1.05/1.02) ≈ 1.235. Because U.S. inflation (5%) exceeds euro-area inflation (2%), more USD are needed to buy one EUR. The USD depreciates, consistent with the higher-inflation currency losing purchasing power.

• AA. Incorrect. Reverses the direction; the higher-inflation currency (USD) should depreciate, not appreciate.
• BB. Incorrect: 1.20 x 1.05 = 1.26 applies only U.S. inflation and ignores euro-area inflation. Relative PPP uses the ratio (1.05 / 1.02), which gives about 1.235.
• CC. Correct. Matches the relative PPP calculation and the correct direction (USD depreciates as the higher-inflation currency).
• DD. Incorrect: 1.20 x 1.02 = 1.224 applies only euro-area inflation. Relative PPP requires the ratio of U.S. to euro-area inflation (1.05 / 1.02), which gives about 1.235.

• Source: Exam outline: CFA Institute 2026 Level I Topic Outlines (learning outcomes), accessed October 2026