Final answer:
Option 2 is correct: A federal budget surplus will cause interest rates to decline. This occurs because the government may borrow less and pay down debt, reducing the demand for money and potentially lowering interest rates as a result.
Step-by-step explanation:
The correct statement concerning interest rates among the provided options is: A federal budget surplus will cause interest rates to decline. Let's analyze why this is the case and dismiss the incorrect options one by one. A decrease in the money supply typically leads to increased interest rates since less money in the economy generally means that lenders can charge a premium for limited funds.
Economic expansions are often associated with rising interest rates because as the economy grows, demand for money increases, which can drive up the cost of borrowing. Lastly, rising interest rates in foreign countries can attract investors seeking higher returns, which could lead to an increase in U.S. interest rates to remain competitive. However, a federal budget surplus, implies that the government's revenue exceeds its expenditures, meaning the government can either pay down existing debt or not issue new debt as aggressively. This can lead to a decrease in demand for money and potentially lower interest rates since the supply of available funds from lenders remains steady or increases.
The effect on specific market interest rates is governed by supply and demand dynamics within those markets. Moreover, when discussing international consequences, if U.S. interest rates decline relative to the rest of the world, this would likely result in a decreased demand for dollars, an increased supply of dollars, and a depreciation of the dollar relative to other currencies, like the euro, since investors may seek higher returns elsewhere.