Key Economic Indicators that Every Accountant Should Know

Presented by : M K Lai E-series course

Key Economic Indicators that Every Accountant Should Know

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About the Speaker

Mr. M. K. Lai, PhD, CFA, is the Principal Consultant ofExecutive Training and Management Consultancy CompanyLimited. He provides professional consulting services andquality training programmes to different financial institutions,business firms, professional bodies and academicorganizations. He obtained a doctorate in finance at LondonBusiness School. He is a CFA charterholder. He haspublished a number of professional books and articles.

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Course Outline

§ to understand how economic indicators can measure economic activities and growth;

§ to understand the fiscal indicators and their relationship to the fiscal policy;

§ to understand the monetary indicators and their relationship to the monetary policy; and

§ to understand how financial markets typically react to the trend of an economic indicator.

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What are Economic Indicators?

§ economic indicators are data that are released by the government or organizations to give insight into the performance of an economy, which can impact the profitability of positions on a range of financial markets, including forex, stocks and bonds

§ they can be used to analyze current and future trends for investment purposes or to judge the health of an economy

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What are Economic Indicators?

§ like all numerical figures, economic indicators can be manipulated to demonstrate almost anything – it is important to learn how to properly read economic indicators, cut through any media hype and make up your own mind about what they show, requiring no prior knowledge of economics or statistics

§ this course aims to explain§what they are;§what they cover;§what their significance is; and§how they should be interpreted

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Purposes of Economic Indicators

§ to give an understanding of the state of an economy§ to influence public policy making and decisions

§e.g. in view of an economic situation, the government may carry out fiscal and monetary policies to stabilize an economy

§ to provide information that can help traders, analysts and investors to discover investment opportunities and adjust their portfolios§ they are used in fundamental analysis, e.g. strategies have to forecast

economic outlook and to prepare economic report §analysts predict upcoming data release to shape their trading strategies, e.g. to

adjust the weights of stock investment in different sectors in view of the forecast economic outlook (sector rotation)

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Purposes of Economic Indicators

§ if actual figures are different from the expectations, traders and investors adjust their portfolios

§ financial markets tend to move dramatically around each release as the market participants adjust their portfolios, i.e. financial markets react to the release of economic indicators

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Uses of Economic Indicators

§ to get better return on investment§ to measure companies and their products§ to judge if it is the right time to carry out a business strategy,

e.g. launch a new project, initiate a takeover or to enter into a new market

§ to better understand how an economy is performing§ to judge the effectiveness of government policies§ to get a feel for an unfamiliar economy, e.g. the investment

opportunities of an emerging market

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Uses of Economic Indicators

§ to compare the performance of different countries§ to make an economic forecast

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Basic Methods of Interpreting Economic Indicators and their Associated Problems§ it is important to distinguish between the effects of inflation

and changes in the real level of economic activity§ economic indicators measure one of three things

§volume, e.g. barrels of oil§price, e.g. the price of 1 barrel of oil§value, e.g. market value of oil produced in a year§notice: value = volume x price§ the value of output increases because of (1) an increase in the price (i.e.

inflation effects); (2) an increase in the volume (real level of economic activity); or (3) both

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Basic Methods of Interpreting Economic Indicators and their Associated Problems§ values, current prices, nominal prices and nominal terms

include the effects of inflation§ volumes, constant prices, real prices and real terms exclude

any inflationary effects§ price indicators used to convert between current (nominal)

and constant (real) prices are called price deflators, e.g. price deflator = current price/constant price

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Index Number

§ any series of numbers (including economic time series) can be converted into index numbers, an economic indicator can be expressed in terms of an index number§a reference base is selected, e.g. 100 (base value for the index) for the base

year 0§ the value in the reference base is dividend by 100 , say, the value is 12,000 and

12,000/100 = 120 for the base year 0 §all numbers in the data series are divided by the result of the previous step, e.g.

in year 1, the value is 12,500, index for year 1 = 12,500/120 = 104.17

§ index numbers are values expressed as a percentage of a single base figure

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Index Number

§ index numbers have no units§ two or more indices can be combined to form a composite

index according to a weighting scheme, e.g. base weighting (using the same weights throughout) vs. current weighting (calculate a new set of current weights at regular intervals)

§ the percentage change indicates the size of a change when the starting level is 100 and it provides a consistent yardstickfor interpreting changes (positive change is always considered as “growth”)

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Index Number: Common Traps

§ do not confuse percentage points with percentage changes, if an inflation rate increases from 2% to 4%, it has risen by 2 percentage points, but the percentage change is (4%-2%)/2% = 100%

§ a percentage increase followed by the same percentage decrease results in a figure below the starting level, e.g. 50% rise followed by a 50% cut leaves you 25% worse off§starting level 100§50% increase: new level = 100*(1+50%) = 150§50% decrease: new level = 150*(1-50%) = 75 (25% worse off from 100)

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§ starting level matters, e.g. a 10% pay rise for a CEO earning $1 million a year puts an extra $100,000 in his annual pay packet while the same percentage increase for a cleaner earning $10,000 a year gives him mere $1,000 extra

§ growth rates will compound, e.g. if the consumer spending rises by 1% a month, it will rise to 12.68% over a full year [(1+1%)12 – 1]

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§ cyclical variations (such as the economic or business cycle) may disguise the trend§one way to smooth out erratic fluctuations is to use a sequence of averages

(known as moving average) which helps to smooth out the economic cycle and show the trend more clearly

§ most economic figures show a seasonal pattern (known as seasonality) that repeats itself every year

§ seasonal adjustment adjusts the raw data for the observed seasonal pattern

§ statistical discrepancies or omissions are items that cannot be explained

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§ the data publisher may revise the data from time to time (known as revision) – it is important to use the most updated data

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Index Number: Cyclical Variationsreal GDP

time

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Index Number: Seasonality

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Types of Economic Indicators

§ leading indicators, which are used to predict the future movements and trends of an economy because they change before the economy does

§ coincident indicators, which are the result of specific economic activities and can be used as metrics for a particular sector or area because they are real-time snapshots of the economy

§ lagging indicators, which can provide essential insights into the health of an economy because they trail the economy and are released after economic activity occurs

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Key Economic Indicators

§ gross domestic product (GDP)§ labor: labor force and unemployment, and wage§ prices and inflation§ balance of trade§ business performance: industrial production and PMI§ housing and property§ fiscal indicators: government accounts§ monetary indicators: money supply, interest rates, exchange

rates

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Gross Domestic Product (GDP)

§ GDP is a measure of the total value of production of all resident producing units of an economy in a specified period, typically a year, before deducting the consumption of fixed capital

§ per capita GDP is obtained by GDP in a year divided by the mid-year population of that economy in the same year and it reflects the economic well-being of an economy on a per person basis

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§ GDP by expenditure component: GDP = private consumption expenditure + gross domestic fixed capital formation + changes in inventories + government consumption expenditure + net exports of goods (i.e. exports - imports)§ interpretation: it provides detailed analysis of private and total spending in an

economy§notice: equivalently, GDP can also be considered as the economic output

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§ real GDP reflects changes in the volume of goods and serviced produced or purchased from one period to another by excluding the inflationary effect, i.e. measure GDP at constant prices§ interpretation: per capita real GDP measures the standard of living in an

economy

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§ economic growth rate is measured by the percentage change in the real GDP of an economy, which reflects the level of economic activity and the health of the economy§when the economic growth rate is positive, the economy is expanding§when the economic growth rate is negative, the economy is contracting§when there are two or more consecutive quarters of negative economic growth,

it enters into a recession§ interpretation: change in economic growth rate reflects the stage of the

business/economic cycle

§ GDP deflator measures the rate of change in the implicit price deflator of GDP § interpretation: it can be used to measure the overall inflation in an economy

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Gross Domestic Product (GDP): Expenditure Components

Source: HK Annual Digest of Statistics

economic wellbeing per personeconomic growth rate

real GDP

expenditure components

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Gross Domestic Product (GDP): Business Cyclereal GDP

time

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Gross Domestic Product (GDP): Price Deflator

overall inflation


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§ financial market reaction§when investors expect recession, corporate earnings fall and investors are less

keen to buy equities and, dragging their prices down (a bear market)§as soon as there is a glimmer of economic recovery, corporate earnings start to

rise and investors switch into equities, pushing up their prices (a bull market)§stock prices can act as valuable leading indicators of expectations§however, stock market reaction may be distorted by government policies, at

least in the short run§higher economic growth is usually accompanied by a rise in interest rates,

which makes bond prices lower§higher economic growth usually increases the value of the local currency

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Labor Force and Unemployment

§ labor force refers to the land-based non-institutional population aged 15 and over who satisfy the criteria for being classified as employed population or unemployed population§ interpretation: it measures the maximum potential economic output

§ labor force participation rate refers to the proportion of labor force in the total land-based non-institutional population aged 15 and over, i.e. participation rate = labor force/total population under the above definition§ interpretation: it measures the proportion of the population that can potentially

produce the economic output

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§ employed population consists of persons aged 15 and over who have been engaged in performing work for pay or profit during the 7 days before enumeration or have had formal job attachment§ interpretation: it is a measure of the current potential economic output§employment can be further analyzed by sectors

§ GDP divided by the employed population measures the economic output per unit of labor§ interpretation: it measures the efficiency and potential total economic output in

terms of labor productivity which is usually expressed as an index number§sources of economic growth: DGDP = Dtechnological progress + Dlabor

productivity + Dcapital productivity

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Labor Force and Unemployment: Employment by Sector


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§ unemployed population comprises all those persons aged 15 and over who fulfil the following conditions§have not had a job and should not have performed any work for pay or profit

during the 7 days before enumeration§have been available for work during the 7 days before enumeration§have sought work during the 30 days before enumeration§ interpretation: it can measure the spare labor capacity that are not used in

producing the economic output

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§ unemployment rate refers to the proportion of unemployed persons in the labor force§ interpretation: it is another way of measuring the level of economic activity and

it directly follows the business/economic cycleü when an economy is expanding, the unemployment rate usually fallsü when an economy is contracting, the unemployment rate usually rises

§notice: the unemployment rate never drops to zero because of people changing jobs and temporarily recorded as unemployed (frictional unemployment), people whose skills and locations do not match job opportunities (structural unemployment), unemployment due to seasonal variation (seasonal unemployment) and those people who are virtually unemployable (the NEET, residual unemployment)

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§natural rate of unemployment is the unemployment rate at which the demand and supply for labor are in balance and the economy is considered at full employment when the unemployment rate reaches the natural rate

§ financial market reaction§when unemployment rate is higher, people have less income and lower

demand for goods and services, resulting in a falling stock market§however, if investors expect that economic recovery is soon to occur, stock

prices, as leading economic indicators, start to rise before unemployment situation has been improved

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Labor Force and Unemployment; Unemployment Rate


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Wage

§ wage rate reflects the “price” of labor and it refers to the amount of money paid for normal hours of work and thus usually relates to a time unit

§ wage rate includes basic wages and salaries, cost-of-living allowance, meal allowance/benefit, commission and tips, good attendance bonus, shift allowance, guaranteed year-end bonus/payment, and other guaranteed bonuses and allowances; however, overtime pay is excluded

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Wage

§ nominal wage index measures the pure changes in wage rates of employees up to supervisory level by holding constant the structure of the labor force with respect to industry, occupation and sex between two successive rounds of the survey

§ real wage index, obtained by deflating the nominal wage index by the consumer price index (A), indicates changes in the purchasing power of the amount of wages earned§ interpretation: it measures labor costs and influences on consumers’ income

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Wage

§ wages are closely linked to the business cycle §when aggregate demand begins to recover after a recession, producers

respond first by increasing overtime and earnings rise faster than wage rates§when higher demand seems more established do employers take on more

workers, which puts upward pressure on wage rates§when economic output begins to decline, overtime is cut first and earnings rise

less rapidly or fall, resulting in laying-off of employees§wage rates tend to decline as unemployment rises, usually with a lag (known as

wage rigidity)

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Wage


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Wage

§ financial market reaction§ in general, higher wage growth usually accompanies with higher inflation§higher wages give people the ability to spend more but inflation means higher

input costs from raw materials and wages, and firms may have a difficult time passing along these higher costs to customers, resulting in a fall in profits and margins

§ in other words, stock returns tend to be higher when wage growth is lower and lower when wage growth is higher

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Prices and Inflation

§ consumer price index (CPI) measures the changes over time in the price level of consumer commodities and services generally purchased by households§ interpretation: inflation rate is usually calculated as the year-on-year rate of

change in the CPI [(CPI this year – CPI last year)/CPI last year]§ inflation refers to a general rise in prices for goods and services or a decline in

the purchasing power of money§deflation refers to a general decline in prices for goods and services

§ different series of CPIs (A, B and C) are compiled to reflect the impacts of consumer price changes on households in different expenditure ranges

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§ a composite CPI is compiled based on the overall expenditure pattern of the above households taken together to reflect the impact of consumer price changes on the household sector as a whole

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§ financial market reaction§higher inflation makes input prices higher and corporate earnings lower, leading

to better performance of value stocks relative to growth stocks§higher inflation also makes high-dividend-paying stock prices to decline§stocks tend to be more volatile during high inflationary periods§higher inflation causes short-term interest rates to raise, resulting in falling bond

prices and rising yields§higher inflation renders the inflation-adjusted or real return on bonds lower§according to the purchasing power parity, a country with higher inflation tends

to have a depreciating currency against the currency of a country with lower inflation

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Balance of Trade

§ imports of goods refer to goods which have been produced or manufactured in places outside HK and brought into HK for domestic use or for subsequent re-export as well as products of HK which are re-imported

§ exports of goods comprise domestic exports (natural produce of HK or the products of a manufacturing process in HK which has changed permanently or substantially the shape, nature, form or utility of the basic materials used in the manufacture) and re-exports (products which have previously been imported into HK and which are re-exported without having undergone in HK a manufacturing process)

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Balance of Trade

§ merchandise trade balance refers to the net balance between exports and imports of goods§ interpretation: it measures an economy’s fundamental trading position§when exports > imports, there is a trade surplus§when exports < imports, there is a trade deficit§ there are two ways in which a trade deficit may move back into balance

ü if demand in the deficit economy contracts or grows more slowly than that in the surplus economy, the volume of exports will increase relative to the volume of imports

ü imports become more expensive and exports cheaper if the deficit economy’s currency falls in value or if inflation is lower in the deficit economy than in the surplus economy (purchasing power parity)

§similarly, trade surpluses may be eroded by faster economic growth, a stronger currency or higher inflation in the surplus economy

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Balance of Trade

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Balance of Trade

§ financial market reaction§ the deficit economy tends to have a depreciating currency against the currency

of the surplus economy§a trade deficit can have a positive effect on the stock market if the economy is

growing and a negative effect if the economy is struggling to sell its goods internationally

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Business Performance

§ industrial sector includes manufacturing, mining and quarrying, electricity and gas supply, and water supply, sewerage, waste management and remediation activities

§ index of industrial production reflects the changes in local industrial output in real terms, i.e. changes in the volume of local production after discounting the effect of price changes§ interpretation: it measures industrial activities and the value-added output of

industries§ it shows the state of the business cycle as the output of industries producing

capital goods and consumer durables tends to be squeezed most during a downturn

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Business Performance: Industrial Production


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§ manufacturing purchasing managers’ index (PMI) is an index of the prevailing direction of economic trends in the manufacturing and service sectors, ranging from 0 to 100§ interpretation: it consists of a diffusion index that summarizes whether market

conditions, as viewed by purchasing managers, are expanding (>50) , staying the same (=50) or contracting (<50)

§ investors can use the PMI as a leading economic indicator that yields foresight into developing trends in the overall economy

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Business Performance: PMI

Source: Trading Economics

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§ financial market reaction§slowing industrial production or PMI lower than 50 mean that the economy is

contracting and it has a negative effect on the stock market

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Housing and Property

§ average prices of premises are based on an analysis of transactions scrutinized by the Rating and Valuation Department for stamp duty purposes

§ average rents are based on an analysis of rental information recorded by the Rating and Valuation Department for fresh lettings effective in the year being analyzed

§ price and rental indices are derived from the same data that are used to compile average prices and rents§ interpretation: they can be used to measure the overall performance of the

property market in terms of sale and letting

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§ Centa-City Index reflects average secondary private residential property price

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§ financial market reaction§although a booming stock market may result in more discretionary income for

future home buyers, empirical studies show that there is no direct relationship between stock market activity and real estate prices

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Fiscal Policy

§ fiscal policy involves the use of government spending and changing tax revenue to affect a number of aspects of the economy§overall level of aggregate demand in an economy and hence the level of

economic activity with the objective of economic stabilization §distribution of income and wealth among different segments of the population§allocation of resources between different sectors and economic agents

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Fiscal Policy

§ expansionary fiscal policy to stimulate a sluggish economy§cuts in personal tax to raise disposable income of individuals, which may

encourage private consumption§cuts in corporate tax to boost business profits, which may raise capital

investment§more public expenditure on social goods and infrastructure to raise public

spending§as a result, it may raise employment and economic output

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Fiscal Policy

§ contractionary fiscal policy to cool an overheating economy§ increases in personal tax to reduce disposable income of individuals, which

may discourage private consumption§ increases in corporate tax to reduce business profits, which may cut capital

investment§ less public expenditure on social goods and infrastructure to reduce public

spending§as a result, it may slow down the rising wages and prices

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Fiscal Policy

§ a key concept is the government budget§budget surplus occurs when tax revenue > public spending§budge deficit occurs when tax revenue < public spending§balanced budget results when tax revenue = public spending

§ an increase in budget surplus would be associated with contractionary fiscal policy

§ a rise in budget deficit would be associated with expansionary fiscal policy

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Fiscal Policy

§ tools §automatic stabilizer: over the course of a business cycle, the budget surplus will

vary automatically in a countercyclical way, e.g. when an economy slows and unemployment rises, government spending on social insurance and unemployment benefits will rise and add to aggregate demand

§discretionary fiscal policy: the government use public spending and tax policy at its own discretion to stabilize the level of economic activity (economists usually look at the structural budget surplus/deficit as if the economy was at full employment as the benchmark to identify the “discretionary” component in the budget

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Fiscal Policy

§ deficits and national debt§government deficits are usually financed by borrowing from the private sector§national debt is the accumulation over time of these deficits§when the ratio of national debt to GDP rises beyond a threshold level, the

solvency of an economy comes into question§government borrowing may divert private sector investment from taking

place(known as crowding out) by leading to higher interest rates

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Fiscal Indicators

§ fiscal indicators are concerned with government revenue and expenditure, which are significant influences on the circular flow of incomes

§ as discussed in fiscal policy, fiscal activities allow governments to provide services, redistribute income and influence the overall level of economic activity

§ government accounts§government revenue§government expenditure§budget

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Fiscal Indicators: Government Revenue

§ direct taxes: earnings and profits tax§ indirect taxes: duties, general rates, motor vehicle taxes,

royalties and concessions, bets and sweeps tax, stamp duties, air passenger departure tax, fees and charges (tax-loaded fees), estate duty and taxi concessions

§ operating revenue = direct taxes + indirect taxes§ capital revenue = land premiums + investment income earned

from the capital revenue, loan repayments received by the various Funds and recovery of the land costs for the flats sold under the Home Ownership Scheme from the HK Housing Authority

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§ government revenue = operating revenue + capital revenue§ interpretation: it measures the different sources of revenue to the government§ it affects aggregate demand and finance government spending

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Fiscal Indicators: Government Expenditure

§ government expenditures by policy area group include community and external affairs, economic, education, environment and food, health, housing, infrastructure, security, social welfare and support§ interpretation: it measures the different uses of government spending§ it affects aggregate demand and the size of the budget deficit/surplus

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Fiscal Indicators: Government Expenditure


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Fiscal Indicators: Budget

§ at the end of February every year, the Financial Secretary gives a Budget Speech to review the government revenue and expenditure in the previous year and forecast these figures in the coming year

§ budget balance, deficit or surplus§ interpretation: it shows the government’s fiscal stance (government revenue –

government expenditure)§ fiscal policy is said to have tightened if a deficit is reduced or converted into a

surplus (contractionary fiscal policy)§ fiscal policy is said to have loosen if a surplus is reduced or converted into a

deficit (expansionary fiscal policy)

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§ financial market reaction§ the budget impacts the economy, the interest rate and the stock market§ the extent of the deficit and the means of financing it influence the money

supply and the interest rate in the economy§e.g. if the budget deficit is larger and it is financed by national debt, it results in

higher interest rates; higher interest rates mean higher cost of capital for the businesses, lower profits and hence lower stock prices; higher interest rates also mean lower bond prices

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Monetary Policy

§ monetary policy refers to central bank activities that are directed toward influencing the quantity of money and credit in an economy§ in Hong Kong, the de facto central bank is the Hong Kong Monetary Authority

(HKMA) with the following objectivesü maintain HK’s monetary stability through the Linked Exchange Rate systemü promote the stability and integrity of HK’s financial system (including the banking

system)ü maintain HK’s status as an international financial center, including the development

of financial infrastructureü manage HK’s Exchange Fundü notice: because of the Linked Exchange Rate system, there is little room for the

HKMA to implement the monetary policy

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Monetary Policy

§ expansionary monetary policy to stimulate a sluggish economy§ increase liquidity (money supply) by cutting the policy rate §encourage private consumption and private investment through personal and

corporate borrowing§as a result, it may raise employment and economic output

§ contractionary monetary policy to cool an overheating economy§ reducing liquidity (money supply) by increasing the policy rate §discourage private consumption and private investment through cuts in

personal and corporate borrowing§as a result, it may slow down the rising wages and prices

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Monetary Policy

§ tools of monetary policy§open market operations: the purchase and sale of government securities in the

open market (buy government securities for expansionary monetary policy)§setting policy rate: it is usually the rate at which the central bank is willing to

lend money to commercial banks (lower interest rate for expansionary monetary policy)

§adjusting reserve requirements: the money creation process is more powerful the lower the percentage reserve requirements of banks (lower required reserve ratio for expansionary monetary policy)

§quantitative easing (QE): the central bank buys at scale government securities and other financial assets to inject money into the economy (buy government securities and other financial assets for expansionary monetary policy)

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Monetary Policy

§ money supply and inflation§ there is usually a positive relationship between money supply and inflation

(more money supply, higher inflation), and inflation targeting can be an objective of the central bank

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Monetary Indicators

§ monetary indicators include information on money supply, interest rates and exchange rates

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Monetary Indicators: Money Supply

§ in Hong Kong, definition of money supply§monetary base (often called M0): Certificates of Indebtedness (for backing the

banknotes issued by the note-issuing banks) + currency held by public + sum of balances of clearing accounts kept with HKMA (aggregate balance) + Exchange Fund Bills and Notes

§M1: currency held by public + demand deposits§M2: M1 + savings and time deposits with licensed banks + NCDs issued by

licensed banks and held by the public§M3: M2 + deposits with restricted licensed banks and deposit taking companies

+ NCDs issued by restricted licensed banks and deposit taking companies and held by the public

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§ money supply includes currency in circulation and bank deposits§ interpretation: it indicates the level of transactions (money is used as a medium

of exchange) and inflation (there is a positive relationship between money supply and inflation, especially when there is full employment)

§an expansionary monetary policy increases money supply§a contractionary monetary policy reduces money supply

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§ financial market reaction§stock prices tend to move higher when the money supply is high because more

money is circulating in the economy to invest in stocks§more money supply reduces interest rates, which leads to higher bond prices§more money supply reduces interest rates, which makes the local currency

depreciate against the foreign currency in the short run§however, in the long run, according to the covered interest rate parity, lower

interest rates result in an appreciating currency

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Monetary Indicators: Interest Rates

§ in Hong Kong, two important reference interest rates are the best lending (or prime) rate and the Hong Kong Interbank Offer Rate (HIBOR)

§ the interest rate at which the HKMA lends to the banking system is called the base rate (based on the discount rates for repurchase transactions through the Discount Window) § the base rate is set at either 50 basis points above the lower end of the

prevailing target range for the US federal funds rate or the average of the five-day moving averages of the HIBORs, whichever is higher

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§ interest rates reflect the cost of capital to the borrowing entities§ interpretation: they indicate the central bank’s monetary policy, influences bank

reserves and monetary growth (the reference rates are usually used as the benchmark for floaters); they also indicate expectations of market participants and creditworthiness of borrowing entities)

§central bank tends to keep liquidity (money supply) and short-term interest rates at or nearer to target level

§an expansionary monetary policy cuts interest rates§a contractionary monetary policy raises interest rates§ lower interest rates encourage borrowing, leading to more private spending and

investment, increased imports, a higher level of economic activity and possibly faster inflation

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§ lower interest rates make the local currency depreciate against the foreign currency in the short run

§however, in the long run, according to the covered interest rate parity, lower interest rates result in an appreciating currency

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§ financial market reaction§higher interest rates tend to negatively affect earnings and stock prices§higher interest rates tend to make bond prices lower§ in the short run, higher interest rates lead to an appreciating local currency

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Monetary Indicators: Effective Exchange Rate Index§ effective exchange rate index measures the average

exchange rate against a basket of currencies§ interpretation: it shows the overall exchange rate movement§ it is a weighted average of many currency movements with weights chosen to

reflect the relative importance of each currency in the economy’s international trade

§an increase in the index indicates a strengthening currency; however a substantial change in the index can be destabilizing

§ it does not take into account of inflation so it does not reveal anything about changes in the economy’s competitiveness (which can be shown through the real exchange rate index)

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Monetary Indicators: Effective Exchange Rate Index


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Monetary Indicators: Effective Exchange Rate Index§ financial market reaction

§an increase in the index means that the local currency is appreciating against a basket of currencies

§a decrease in the index means that the local currency is depreciating against a basket of currencies

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Wrap-Up

§ introduce the following key economic indicators and discuss the financial market reaction to each of them§gross domestic product§unemployment rate and wage§consumer price index§ trade balance§ industrial production and PMI§property price and rental indices§ fiscal indicator: budget§monetary indicators: money supply, interest rates and effective exchange rate

index

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Quiz

(1) Which of the following statements correctly describes a recessionary economy?a. The gross domestic product has been declining for two or more consecutive quarters.b. The unemployment rate has been falling.c. The growth of wage rate has been accelerating.d. The interest rates have been rising.

(2) The consumer price index is 105 this year and it was 100 last year. What is the annual inflation rate for the year?a. 5%b. -5%c. 4.76%d. -4.76%

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Quiz

(3) When the PMI is equal to 52, it means that the market conditions are:a. contracting.b. the same.c. expanding.d. unknown until it is compared to the previous figure.

(4) Which of following actions of the government is consistent with the objective of cooling an overheating economy?a. To enlarge the budget deficit.b. To cut government expenditure.c. To cut the direct and indirect tax rates.d. To borrow more national debt.

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Quiz

(5) Which of the following actions of the central bank is consistent with an expansionary monetary policy?a. The central bank sells government securities in the market.b. The central bank raises the required reserve ratio.c. The central bank sells other financial assets in the market.d. The central bank cuts the policy rate.

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Answers

1) a2) a3) c4) b5) d

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– Investment Biases that Every Accountant Should Know– Personal Risk Profiling that Every Accountant Should Know– Behavioral Corporate Finance that Every Accountant Should

Know– Bond and Stock Indicators that Every Accountant Should

Know– Why We Do Not Make the Best Investment Choices

You may also interested in the following e-series:

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End of Learning

Thank you very much

By : M K Lai

Key Economic Indicators that Every Accountant Should Know

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