Question

What impact can the government’s budget deficit have on the dollar value in the foreign exchange market?

Can the government’s Budget Deficit cause Trade Deficits?

Answer 1

Increase in deficit spending results in short term appreciation of currency

The depreciation of the currency depends on method use to finance the deficit.

A budget deficit increases, demand in market for domestic financial capital which causes increase in interest rates.

Increased interest rates causes inflow of foreign capital and Improve Exchange rate for US dollars and decrease in its supply.

This budget deficit is accompanied by trade deficit.

Budget deficit and trade deficit go hand in hand

If there is change in government budget balance it doesn't mean that trade deficit will also change.

For example if government budget balance turned from deficit to surplus.

Trade deficit might remain large and growing.

Exchange rates also Explains the link between budget deficit and trade deficit.