What does macroeconomic theory predict as the main economic effect of a reduction in the budget deficit?
A)lower real interest rates
B)a drop in the exchange rate
C)an increase in net exports
D)All of the above are correct.

Question

What does macroeconomic theory predict as the main economic effect of a reduction in the budget deficit?
A)lower real interest rates 
B)a drop in the exchange rate 
C)an increase in net exports 
D)All of the above are correct.

Quizplus · Accepted Answer

According to macroeconomic theory, a reduction in the budget deficit would lead to lower real interest rates due to decreased demand for borrowing, which in turn would encourage investment and consumption. A drop in the exchange rate would occur because reduced government borrowing will lead to less demand for foreign capital to finance government spending, and the decrease in demand for foreign capital should lead to a decline in the exchange rate. Finally, an increase in net exports occurs because a reduction in the budget deficit can lower interest rates, lowering the cost of capital, which increases demand for domestic goods and services, indirectly raising the price of domestic goods and services on global markets, and so increasing exports.

What Does Macroeconomic Theory Predict as the Main Economic Effect