Final answer:
Appropriate fiscal policy during an economic downturn typically involves increasing government spending or decreasing taxes, which can raise interest rates. Higher interest rates might lead to currency appreciation. The anticipation of currency appreciation can influence yields on government bonds, potentially leading to lower yields as investors factor in expected currency gains.
Step-by-step explanation:
If a country is facing an economic downturn, appropriate fiscal policy, such as increasing government spending or decreasing taxes, is often used to stimulate economic growth. When the government implements expansionary fiscal policy, it increases the demand for financial capital as it borrows more to fund its spending. This increased demand can lead to higher interest rates, as lenders will require a higher return on the increased supply of bonds or other government securities. However, high interest rates can attract foreign investment, increasing the demand for the country's currency, thereby causing it to appreciate in value.
In the scenario where a country's currency is expected to appreciate, investors may expect higher returns on investments denominated in that currency. Therefore, expected exchange rates can impact yields on government bonds. If the currency is anticipated to appreciate, yields may decrease as investors are willing to accept lower returns in exchange for the anticipated gains from the currency's appreciation. It's essential to note that international financial investors can influence this dynamic significantly. If they expect the currency to appreciate, they might invest more, but they could also withdraw funds quickly, causing a rapid depreciation of the exchange rate and a potential financial crisis if their expectations change.