Question

Assume country A is a small open economy (so that interest rates in Country A reflect interest rates in global capital markets). Explain why the following statement can be true.

Statement: If Country A reduces its budget deficit, yields on Country A sovereign debt should fall

Answer 1

a countrys budget deficit is when its expenditure is more than its revenue and a countrys debt is its accumulated deficit. say for example country A's revenue in the year 1 is 500$ and its expenditure in that year is 600$, in year 2 the revenue is 400$ and the expenditure is 800$ then the deficit in year 1 and 2 is respectively 100 and 400 $ so the debt in the second period is 500$. soverign debt is nothing but the national debt or we can say how much a countrys government ows to the external sources. so if country A reduces its budget then the sovereign debt will definitly fall. and the yield on soverign debt will also fall.

another possible reason could be that if government wants to reduce the deficit it will start to spend less and that way money supply will decline and the rate of interest will rise. as we know there exist inverse relationship between rate of interest and bonds the soverign debt holders yield will decline here.