In a small open economy with perfect capital mobility, a reduction in the government's budget deficit ______ net exports and the real exchange rate ______.

Question

Quizplus · Accepted Answer

A reduction in the government's budget deficit typically leads to lower interest rates, which reduces inflows of foreign capital, depreciating the currency. This depreciation makes exports cheaper and imports more expensive, thus increasing net exports.

In a Small Open Economy with Perfect Capital Mobility, a Reduction