United States
Hong KongThe economics you actually need
Business cycle phases, monetary and fiscal policy and their effects, the relationship between interest rates and bond prices, the yield curve, inflation and real returns. Conceptual rather than quantitative.
A small, cheap topic. An hour of work, and the questions are among the more straightforward on the paper.
The business cycle
Expansion, peak, contraction, trough. Repeat.
What is examined is the association: which asset classes and sectors tend to do well in each phase, and which indicators are leading, coincident or lagging.
Leading indicators include new orders, building permits, stock prices and the yield curve. Unemployment is a lagging indicator, which is the one people get wrong.
Monetary policy
The central bank, working through interest rates, open market operations and reserve requirements.
| Action | Effect |
|---|---|
| Lower rates | Expansionary - borrowing cheaper, spending encouraged |
| Raise rates | Contractionary - borrowing dearer, inflation restrained |
| Buy securities | Expansionary - money supply increases |
| Sell securities | Contractionary - money supply decreases |
| Lower reserve requirements | Expansionary - banks can lend more |
Fiscal policy
Government spending and taxation, controlled by the legislature rather than the central bank. Higher spending or lower taxes is expansionary; the reverse is contractionary.
Questions confuse the two deliberately. Interest rates are monetary. Tax rates are fiscal.
The yield curve
Normal - upward sloping, longer maturities yielding more. Flat - little difference. Inverted - short yields exceed long, historically associated with subsequent recessions.
Inversion is the shape questions ask about, because of the recession association.
It is the most examined relationship in this section and the one to hold without hesitation. Rates up, existing bond prices down. Longer duration means a larger move.
Inflation and real returns
The real return is what remains after inflation. The approximation is nominal minus inflation; the exact form divides one plus the nominal by one plus inflation and subtracts one.
The consumer price index is the usual measure. Retirement projections often need the inflation-adjusted rate, which is where this connects to the retirement domain.
What is not tested
Macroeconomic modeling, forecasting, or anything requiring a graph. This section is about recognizing relationships, and the questions reflect that.
Every dollar limit here is indexed annually and several were changed by recent legislation. Confirm the current figure against the IRS or the relevant authority before relying on it, and expect the exam to test the rule rather than the number.
Common questions
What economics is on the CFP exam?
Business cycle phases and indicators, monetary and fiscal policy, the relationship between interest rates and bond prices, the yield curve, and inflation and real returns.
What is the difference between monetary and fiscal policy?
Monetary policy is the central bank working through interest rates, open market operations and reserve requirements. Fiscal policy is government spending and taxation set by the legislature.
Is unemployment a leading indicator?
No, it is lagging. Leading indicators include new orders, building permits, stock prices and the yield curve, and this is the distinction candidates most often get wrong.
What does an inverted yield curve mean?
Short-term yields exceed long-term ones, which has historically been associated with subsequent recessions. It is the shape questions ask about.
How do you calculate a real return?
Divide one plus the nominal rate by one plus inflation and subtract one. Nominal minus inflation is an approximation that is close at low rates and produces a plausible wrong answer.