CFA Economics Notes: GDP, Central Banks and Foreign Exchange [Level 1]

These CFA economics notes cover the topic that links markets to the wider economy. Economics carries a 6 to 9 percent weight in the 2026 CFA Level 1 exam, according to CFA Institute. The topic has 8 learning modules. That range equals roughly 11 to 16 of the 180 exam questions, all tested in Session 1. This note explains GDP, central bank tools and foreign exchange, with worked examples and exam traps. Build your plan from the CFA notes hub.

CFA economics notes: what the topic covers

Economics tests how output is measured, how central banks and governments steer the economy and how currencies move. Learn the GDP formula, the money multiplier, the Fisher effect and covered interest rate parity, then practice the worked examples below until each number feels automatic.

GDP and aggregate output in CFA economics notes

Gross domestic product, or GDP, is the market value of all final goods and services produced in a country. The expenditure approach is the formula the exam tests most: GDP equals consumption plus investment plus government spending plus net exports, or GDP = C + I + G + (X – M). Only final goods count, so intermediate goods are left out.

Nominal GDP values output at current prices, so it rises when prices rise even if nothing extra is produced. Real GDP uses base year prices, so it tracks the volume of production. The GDP deflator converts one into the other: real GDP equals nominal GDP divided by the deflator times 100. Real GDP growth is the change in real GDP over last year real GDP. GDP also misses unpaid home production, the underground economy and environmental damage.

Worked example: GDP, real GDP and growth

Take a fictional country, in billions of dollars: consumption $12,400, investment $3,600, government spending $3,800, exports $2,900 and imports $3,700. Net exports are -$800. GDP is $12,400 plus $3,600 plus $3,800 minus $800, or $19,000 billion. The GDP deflator is 112.5 (base year = 100). Real GDP is $19,000 divided by 1.125, or $16,888.89 billion. Last year real GDP was $16,200 billion. Growth is ($16,888.89 minus $16,200) divided by $16,200, or 4.25 percent.

Market structures and the business cycle

Four market structures frame the microeconomics half: perfect competition (many firms, identical products), monopolistic competition (differentiated products), oligopoly (a few large firms) and monopoly (one firm). In every structure, produce where marginal revenue equals marginal cost, and shut down when price falls below average variable cost.

The business cycle has four phases: expansion, peak, contraction and trough. Leading indicators such as new orders turn before the economy. Coincident indicators such as payrolls move with it. Lagging indicators such as unemployment turn after it.

Unemployment has three types: frictional, structural and cyclical. Inflation is a rise in the general price level. Demand-pull inflation comes from spending that outruns supply, and cost-push inflation from rising input costs.

Monetary policy and central banks in CFA economics notes

A central bank runs monetary policy to hold prices stable and employment full. It uses three tools: the policy rate charged on bank reserves, open market operations that buy or sell securities to move rates, and reserve requirements on bank deposits.

In addition, money creation follows the money multiplier, which equals 1 divided by the reserve requirement. With a 10 percent requirement, the multiplier is 10, so a new deposit of $1,000 can expand total deposits to $10,000, creating $9,000 of new money. Lower policy rates make borrowing cheaper, lift spending and investment, and push asset prices up. Higher rates do the opposite.

Next, the Fisher effect connects rates and inflation: the nominal rate is approximately the real rate plus expected inflation. For example, a nominal rate of 5.5 percent with expected inflation of 2.5 percent implies a real rate near 3.0 percent. The Taylor rule gives the same logic in policy form: the bank raises its rate when inflation runs high.

Fiscal policy: spending, taxes and the multiplier

Fiscal policy is the government side: spending and taxation. Expansionary policy raises spending or cuts taxes to lift demand in a contraction. Contractionary policy does the reverse when inflation runs hot. The fiscal multiplier measures the punch: a spending change moves GDP by a multiple of the original change. With a marginal propensity to consume of 0.8, the simple multiplier is 1 divided by (1 – 0.8), or 5. As a result, $100 of extra spending can lift GDP by $500.

Two limits matter at Level 1. First, crowding out happens when government borrowing lifts rates and squeezes private investment, which shrinks the multiplier. The budget deficit is one year gap between spending and tax revenue, while public debt is the accumulation of past deficits. The exam separates the two cleanly.

International trade and the balance of payments

Trade rests on comparative advantage: a country gains by exporting what it produces at the lowest opportunity cost and importing the rest. A tariff taxes imports, a quota caps volume, and a subsidy pays domestic producers to undercut imports. The balance of payments records every transaction with the rest of the world. Trade, income and transfers sit in the current account. Capital transfers sit in the capital account. Investment flows sit in the financial account. Together, the accounts sum to zero, so a current account deficit is funded by a financial account surplus.

Foreign exchange and exchange rates in CFA economics notes

The foreign exchange market sets the price of one currency in another. A spot rate is the price for immediate delivery. A forward rate is the price agreed today for delivery later. Rates are quoted as units of one currency per unit of another, so USD/EUR 1.0800 means one euro costs 1.0800 dollars. A rise in the quote means the base currency has strengthened.

Regimes range from free floating, where the market sets the rate, to managed float, where the central bank smooths moves, to a fixed peg, where the rate is tied to another currency. A peg removes currency risk but forces the central bank to defend it with reserves. A weaker currency makes exports cheaper and imports more expensive, so it narrows a trade deficit but lifts import prices.

Two parity conditions tie rates together. Purchasing power parity says the same basket should cost the same everywhere once converted, so relative PPP expects the spot rate to move with the inflation gap between two countries. Covered interest rate parity says the forward rate must offset the interest rate gap, or arbitrage would earn a risk free profit. In short, the higher-rate currency trades at a forward discount, and the lower-rate currency at a forward premium.

Worked example: the forward rate by covered interest rate parity

Suppose the spot rate is 1.0800 US dollars per euro, the US 1-year rate is 4.00 percent and the eurozone 1-year rate is 2.50 percent. The forward rate is 1.0800 times (1.04 divided by 1.025), which is 1.0800 times 1.0146, or 1.0958 dollars per euro. The euro trades at a forward premium of (1.0958 divided by 1.0800) minus 1, or 1.46 percent, because the US rate is higher. Covered interest rate parity holds, so no risk free arbitrage exists. If the market forward rate were higher than 1.0958, an arbitrageur could borrow dollars, convert to euros, invest at the eurozone rate and lock in the sale.

Exam traps that these CFA economics notes warn you about

• Nominal GDP is not growth. A rise in nominal GDP can come from prices alone. Divide by the deflator first.
• Imports subtract in the GDP formula. They are removed because spending already includes foreign goods.
• Shutdown means price below average variable cost. A firm that covers variable cost keeps producing in the short run.
• Unemployment is a lagging indicator. A falling rate confirms a recovery, it does not predict one.
• Higher policy rates strengthen the currency. They attract inflows, which lift demand for the currency.
• Forward premium sits on the low-rate currency. The lower-rate currency trades at a forward premium.
• A deficit is a flow, debt is a stock. The deficit is one year gap. Debt is the total of all past deficits.
• A peg is not a promise that holds forever. A fixed rate removes day to day currency risk, but thin reserves can force a break.

One-page revision box: CFA economics notes

Concept	Formula or rule
GDP, expenditure approach	GDP = C + I + G + (X – M)
Real GDP	Nominal GDP / GDP deflator x 100
Profit maximization	MR = MC; shut down below average variable cost
Money multiplier	1 / reserve requirement; $1,000 at 10 percent expands to $10,000
Fisher effect	Nominal rate is about real rate plus expected inflation
Fiscal multiplier	1 / (1 – MPC); MPC 0.8 gives a multiplier of 5
Forward rate, covered interest parity	F = S x (1 + r domestic) / (1 + r foreign)
Balance of payments	Current account + capital account + financial account = 0
Exam weight	6 to 9 percent, about 11 to 16 of 180 questions, Session 1

Economics rewards candidates who run the numbers instead of memorizing definitions. Work both examples again, then test yourself on the revision box. For the rest of the Level 1 syllabus, return to our CFA Level 1 notes hub. Also read the CFA Quantitative Methods notes for the time value of money behind the forward rate math, and the CFA 2027 curriculum changes guide for the February 2027 exams.

Sources

• CFA Institute Level I exam page: https://www.cfainstitute.org/en/programs/cfa/exam/level-i
• 300hours Economics cheat sheet: https://300hours.com/cfa-level-1-economics-cheat-sheet/
• AnalystPrep Economics notes: https://analystprep.com/cfa-level-1-exam/economics/learning-sessions-curriculum-economics/
• UWorld Level 1 topics: https://finance.uworld.com/cfa/level-1-topics/