Final answer:
A shift from a government budget deficit to a budget surplus often strengthens the domestic currency (option a) due to a reduced need for foreign borrowing and less upward pressure on interest rates, which in turn decreases foreign demand for the domestic currency.
Step-by-step explanation:
When a government shifts from a budget deficit to a budget surplus, it may affect the exchange rate by potentially strengthening the domestic currency. This is because a surplus reduces the need for the government to borrow from foreign lenders, which can decrease the inflow of foreign capital and therefore reduce the upward pressure on domestic interest rates that might arise from borrowing. As a result, there will be less demand for the domestic currency from foreign investors, which can cause the currency to appreciate. Conversely, during a budget deficit, the government borrows more, increasing demand for financial capital and possibly raising domestic interest rates, which attracts foreign capital and can appreciate the exchange rate.
Moreover, higher interest rates in the United States can make U.S. bonds more attractive compared to foreign bonds, leading Americans to purchase fewer foreign bonds and supply fewer U.S. dollars to the international market. This decreased supply of U.S. dollars, in turn, can lead to a stronger exchange rate, making exports more expensive and imports cheaper. Therefore, a budget deficit might cause an influx of foreign investment, a stronger exchange rate, and possibly a trade deficit or reduced trade surplus. The relationships among budgets, interest rates, and exchange rates demonstrate how fiscal policy can impact a country's currency value and trade balance.