Unformatted text preview: causes the real exchange rate to appreciate. 3. . . . which in turn reduces net foreign investment. Figure 30-5 T HE E FFECTS OF A G OVERNMENT B UDGET D EFICIT . When the government runs a budget deficit, it reduces the supply of loanable funds from S 1 to S 2 in panel (a). The interest rate rises from r 1 to r 2 to balance the supply and demand for loanable funds. In panel (b), the higher interest rate reduces net foreign investment. Reduced net foreign investment, in turn, reduces the supply of dollars in the market for foreign-currency exchange from S 1 to S 2 in panel (c). This fall in the supply of dollars causes the real exchange rate to appreciate from E 1 to E 2 . The appreciation of the exchange rate pushes the trade balance toward deficit....
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- Spring '10
- Macroeconomics, President of the United States, budget deficit, Federal government of the United States, loanable funds, net foreign investment