As a country increases its borrowing to finance its foreign trade deficit, interest rates are driven up.

Question

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When a country borrows to finance its foreign trade deficit, there is an increase in the demand for money in the economy. This increase in demand for money leads to an increase in interest rates, as lenders raise rates to compensate for the higher level of risk involved in lending to the government or businesses that are deficit financing. Therefore, as a country increases its borrowing to finance its foreign trade deficit, interest rates are driven up.

As a Country Increases Its Borrowing to Finance Its Foreign