An increase in the U.S. government budget deficit

Question

a. decreases U.S. net exports and U.S. net capital outflow the same amount.
b. increases U.S. net exports and decreases U.S. net capital outflow.
c. increases U.S. net exports and U.S. net capital outflow the same amount.
d. decreases U.S. net exports and increases U.S. net capital outflow.

Answer 1

The correct answer is a. decreases U.S. net exports and U.S. net capital outflow the same amount.

When the U.S. government runs a budget deficit, it typically borrows money to finance its spending. This increased demand for funds can lead to higher interest rates, which can attract foreign investment. As a result, while there may be an increase in capital inflow, it could manifest as a decrease in net exports since higher interest rates can make U.S. assets more attractive, leading to capital inflow and a stronger dollar. A stronger dollar makes U.S. exports more expensive for foreign buyers, thus decreasing net exports.

In summary, an increase in the budget deficit tends to lead to a decrease in both net exports and net capital outflow, as foreign investments come in, reflecting the effects of capital mobility.