If the government finances an increase in government purchases with an increase in taxes, which of the following would you expect to see?

Question

Quizplus · Accepted Answer

Financing an increase in government purchases with an increase in taxes typically leads to an increase in the exchange rate. This is because the combined effect of higher government spending and higher taxes can lead to a higher demand for the domestic currency, as government spending injects money into the economy while taxes withdraw money, potentially leading to less inflationary pressure than if the spending were financed by borrowing. The increased demand for the domestic currency appreciates its value, hence an increase in the exchange rate.

If the Government Finances an Increase in Government Purchases with an Increase