How might an increase in the Federal budget deficit affect the current account balance and the international v?

How might an increase in the Federal budget deficit affect the current account balance and the international value of the dollar, other things being equal?|||Simplified: From the circular flows in the economy we know that the following identity holds:


C + I + G + (X - M) = C + S +T


Where: C: consumption, I: investments, G: government spending, X: exports, M: imports, S: savings, T: taxes.


Rearranging:


(S - I) + (T - G) = (X - M)


In other words: the sum of the private sector financial balance, defined as the difference between savings and investments, and the government deficit is equal to the current account balance. If the budget deficit increases with the private sector balance remaining constant, the current account deficit must deteriorate.





What happens to the US$ is a bit more complicated: a deteriorating current account means that imports increase / exports decrease. This means that there is an excess supply of US$ in the currency markets which results in a devaluation of the US$. This must be offset by an increase of capital inflow into the US to maintain an equilibrium in the balance of payments. This is likely the case when interest rates in the US are higher compared to the rest of the world. This could be the result of the higher budget deficit being financed by additional government bonds, driving the interest rates up. The additional capital inflow in this case is then used to finance the additional budget deficit.