A reduction in a country's government budget deficit shifts both the supply of loanable funds in the market for loanable funds and the supply of dollars in the market for foreign-currency exchange right.
Answer: Option A
Step-by-step explanation:
If the taxes collected are lower than government expenditure, the variation between them is the budget deficit. The loanable funds supply arise from national savings. The demand from domestic investments and net outflows. The dollars supply in the currency market results from the outflow of net capital; the dollars demand on the currency market results from net export.
The net outflow of capital is the link between the two markets. Trade deficits and Government budgets deficits are usually referred as twin deficits. Because Government budgets deficits often cause trade deficits.
The government deficit reduces domestic savings, leading to higher interest rate and less net cash flows. Reducing the outflow of net capital reduces the dollars supply, raising the actual exchange rates. Thus, the trade balances will become a deficit.