In an open economy, what is the expected trade balance outcome when the federal government has a budget deficit?

When the federal government runs a budget deficit, it spends more than it collects in revenue, which can lead to an increase in national borrowing. This borrowing often results in higher interest rates as the government competes for funds in the financial markets. As interest rates rise, it attracts foreign capital, which tends to appreciate the domestic currency.

A stronger domestic currency makes exports more expensive for foreign buyers while making imports cheaper for domestic consumers. Consequently, the increased demand for foreign goods and services, combined with reduced exports, leads to a greater trade deficit. Therefore, the expected outcome in an open economy experiencing a government budget deficit is a trade deficit, as reflected in the correct choice.

This relationship illustrates the interconnectedness of government fiscal policy and international trade dynamics, where budgetary decisions can have far-reaching effects on trade balances.