Question

1. Which of the following would cause the real exchange rate of the US dollar to depreciate? (explain the answer)
a, the U.S government budget deficit decreases
b. capital flight from foreign countries
c. the U.S. imposes import quotas
d. None of the above is correct.

2. Which of the following contains a list of things that increase when the budget deficit of the U.S decreases? (explain the answer)
a. U.S. supply of loanable funds, U.S. net capital outflow, U.S. domestic investment
b. U.S. supply of loanable funds, U.S. exports, the real exchange rate of the dollar
c. U.S interest rates, the real exchange rate of the dollar, U.S. domestic investment
d. the real exchange rate of the dollar, U.S. net capital outflow, U.S. net exports

Answer 1

1. The correct answer is a. When there is a decrease in the budget deficit, then there will be fall in the interest rates when this happens then there will be an increased capital outflow thus decreasing the demand of our currency. This leads to depreciation of our currency.

2. The correct answer is a. A budget deficit is reduced then the government reduces its supply of government bonds. Hence more supply of funds are available for other private projects. Furthermore upon reduction of supply of government bonds, there will be an increase in the price of the demands. And since prices are inversely related to interest rates, the interest rates will fall. This will in turn lead to capital outflow. Furthermore a reduced interest rate also helps to boost up and increase the investment