Which of the following accurately describes of the effect of the government budget deficit on the open economy?
A)Real interest rates fall, which encourages domestic investment; the currency appreciates pushing the trade balance toward deficit.
B)Real interest rates rise, which causes crowding out of domestic investment; the currency appreciates pushing the trade balance toward deficit.
C)Real interest rates fall, which encourages domestic investment; the currency depreciates pushing the trade balance toward surplus.
D)Real interest rates rise, which causes crowding out of domestic investment; the currency depreciates pushing the trade balance toward surplus.

Question

Quizplus · Accepted Answer

When the government runs a budget deficit, it typically borrows to finance the deficit, increasing the demand for loanable funds. This leads to higher real interest rates, which can crowd out some private investment. Additionally, higher interest rates can attract foreign capital, leading to an appreciation of the domestic currency. An appreciated currency makes exports more expensive and imports cheaper, potentially worsening the trade balance.

Which of the Following Accurately Describes of the Effect of the Government