Answer to Question #99835 in Macroeconomics for Tiffany

Question

2. Government fiscal policy and international trade seem to be linked. Let’s investigate their relationship.
a. Say a government is currently running a budget deficit and decides to cut taxes, increase spending, or both. Explain how this will affect interest rates in the country.
b. Given the change in interest rates from part A, what will happen to the value of this country's currency? Explain why.

Answer 1

a. If a government is currently running a budget deficit and decides to cut taxes, increase spending, or both, then this policy will increase aggregate demand, the country will finance the increased deficit with selling more government bonds, and as a result this will increase interest rates in the country.

b. Given the change in interest rates from part A, the value of this country's currency will increase, because the flow of capital into the country will increase, as the interest rates are higher.