Title 2.2 Understanding Business Cycles.pdf ✅

1. An economy is experiencing accelerated GDP growth and businesses have started hiring full-time workers and ordering heavy equipment. This economy is most likely in the: A. peak phase.  B. late expansion phase. C. early expansion phase. Explanation Economies experience business cycle phases of trough, expansion, peak, and contraction. Each phase is associated with certain characteristics regarding GDP growth and inflation. Expansion is divided into early (ie, recovery) and late phases (ie, boom). During an early expansion phase, consumers begin to spend more, and GDP growth becomes moderately positive. Businesses begin to purchase inventory but are hesitant to hire new employees until there is evidence of further economic growth (Choice C). During the late expansion phase, consumer spending increases even further, and GDP growth becomes accelerated. Businesses rehire full time employees and invest in heavy capital equipment. (Choice A) The peak phase follows late expansion and is characterized by decelerating GDP growth and a slowdown in hiring. Things to remember: Economies experience business cycle phases of trough, expansion (early and late), peak, and contraction. In the late expansion phase GDP growth is accelerated, and businesses begin to rehire employees and invest in capital equipment. Describe the business cycle and its phases LOS Copyright © UWorld. Copyright CFA Institute. All rights reserved.
2. Which of the following best describes a characteristic of the early expansion phase of the business cycle? A. Inflation accelerates, leading economic growth B. Capital spending by businesses expands rapidly  C. Consumers accelerate spending on housing and durable goods Explanation The phases of the business cycle are expansion, peak, contraction (ie, recession), and trough. The length of a business cycle, or any specific phase, is not predictable. However, each phase is associated with certain characteristics regarding GDP growth and inflation. Expansions are divided into early (ie, initial recovery) and late phases. The early expansion phase occurs after the economy has been in a trough, which is considered a turning point in the cycle, when economic activities begin to expand. Characteristics of the early expansion phase include the following: Businesses begin to replenish inventories. Consumers start spending more, particularly on housing and durable goods, as incomes stabilize. GDP moves from negative to moderately positive. Central banks generally keep interest rates low to support the expanding economy. Unemployment levels decline but remain high. Layoffs slow, but employers are reluctant to hire new staff without evidence of sustained economic growth. (Choice A) Inflation tends to lag other variables, exhibiting slow growth or even deflation. Inflation catches up to economic growth during the later expansion phase. (Choice B) Early in the expansion, businesses are not yet willing or able to commit to large capital spending plans (eg, new manufacturing facilities, expanding production capabilities). It is during the peak phase that business capital spending expands rapidly since confidence in the business cycle is high. Things to remember: The early expansion phase occurs after the economy has been in a trough, when economic activities begin to expand. GDP growth moves from negative to moderately positive. Consumers start spending more, particularly on housing and durable goods. Describe the business cycle and its phases LOS Copyright © UWorld. Copyright CFA Institute. All rights reserved.
3. Loose private sector credit conditions occurring at the peak of a credit cycle are most likely to:  A. contribute to financial asset price bubbles. B. result in a stronger recovery during the early part of the next economic expansion. C. moderate the economic downturn associated with a contraction of the business cycle. Explanation Business cycles measure changes in economic activity. Financial cycles measure changes in financing and credit conditions. Credit cycles are a subset of financial cycles and describe changes in availability and pricing (ie, interest rates/yields) of private sector credit, which has direct implications for the business cycle. The credit cycle tends to be longer and more extreme than the business cycle. Credit cycle peaks are often a precursor to the peak of the business cycle. They are characterized by loose credit conditions (ie, easily available credit) that contribute to bubbles (ie, unsustainable valuations) in financial assets such as stocks and real estate. Therefore, investors monitor the credit cycle to better understand and anticipate: its alignment with the business cycle, the valuation of financial assets, changes in real estate markets (eg, housing, construction), and government policy actions. Monetary and fiscal policymakers have increasingly focused on the management of financial market stability. This focus is influenced by their recognition that credit cycle peaks are often associated with subsequent banking crises. (Choice B) Since the credit cycle is usually longer than the business cycle, credit tends to be an economic headwind early in the expansion phase of the business cycle. It is not uncommon for credit to still be contracting (tight, not loose) during this first stage of an economic recovery. (Choice C) A peaking credit cycle would intensify (not moderate) the economic downturn associated with a contraction of the business cycle. Typically, credit contraction and the associated reduction in asset values is well underway by the time the business cycle begins its downturn. Things to remember: Loose credit conditions, which often occur at the peak of a credit cycle, contribute to bubbles in financial assets such as stocks and real estate. Describe the business cycle and its phases LOS Copyright © UWorld. Copyright CFA Institute. All rights reserved.
4. Credit cycles are least likely to: A. peak prior to recessions.  B. be countercyclical to business cycles. C. amplify the duration and magnitude of business cycles. Explanation Business cycles measure changes in economic activity. Financial cycles measure changes in financing and credit conditions (eg, pricing, availability, risk attitudes). Credit cycles are a subset of financial cycles and describe changes in availability and pricing (ie, interest rates/yields) of private sector credit, which has direct implications for the business cycle. Credit cycles tend to be procyclical, not countercyclical, to business cycles since credit availability expands during economic expansions and contracts sharply during economic downturns. (Choice A) The credit cycle tends to peak prior to the onset of a recession and is often a precursor to the peak of the economic cycle. As the business cycle slows/contracts, lending institutions often severely restrict credit availability while increasing the cost of credit. (Choice C) Credit cycles tend to amplify the duration and magnitude of the business cycle: when the economy is expanding (contracting), creditors are more (less) willing to lend, so the supply of credit increases (decreases) and its price decreases (increases), accelerating the trend of the business cycle. Things to remember: Credit cycles are a subset of financial cycles and describe the change in availability and pricing of private sector credit, which has direct implications for the business cycle. Credit cycles are procyclical since credit availability expands during economic expansions and contracts sharply during economic downturns. Describe credit cycles LOS Copyright © UWorld. Copyright CFA Institute. All rights reserved.