If a government increases its budget deficit, which statement would best predict the effects?
A) Interest rates rise, and the trade balance moves toward surplus.
B) Interest rates rise, and the trade balance moves toward deficit.
C) Interest rates fall, and the trade balance moves toward surplus.
D) Interest rates fall, and the trade balance moves toward deficit.

Question

Quizplus · Accepted Answer

When a government increases its budget deficit, it will borrow more money, which will increase demand for credit and cause interest rates to rise. As interest rates rise, foreign investors may become more interested in investing in the country's financial markets, which will increase demand for the country's currency and cause it to appreciate. This appreciation will make the country's exports more expensive and imports cheaper, leading to a trade deficit. Therefore, the most likely effects of an increased budget deficit are rising interest rates and a deterioration of the trade balance towards deficit.

If a Government Increases Its Budget Deficit, Which Statement Would