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The Budget Deficit and the Dollar

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  • Martin Feldstein

Abstract

This study examines the reasons for changes in the real exchange rate between the dollar and the German mark from the beginning of the floating rate regime in 1973 through 1984. The econometric analysis focuses on the effects of anticipated structural budget deficits and monetary policy in the United States and Germany and the changes in U.S. profitability induced by changes in tax rules. The possible impact of a number of other variables is also examined. The evidence indicates that the rise in the expected future deficits in the budget of the U.S. government has had a powerful effect on the exchangerate between the dollar and the German mark. Each one percentage point increase in the ratio of future budget deficits to GNP increased the exchange rate by about 30 percentage points. Changes in the growth of the money supply also affect the exchange rate. Changes in the tax rules and in the inflation-tax interaction that altered the corporate demand for funds did not have any discernible effect on the exchange rate. A separate analysis confirms that there is an equilibrium structural relation between the dollar-DM rates in the United States and Germany. An increase of one percentage point in the real interestrate differential has been associated with a rise in the DM-dollar ratio of about five percent.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 1898.

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Date of creation: Apr 1989
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Publication status: published as Martin S. Feldstein. "The Budget Deficit And The Dollar," in Stanley Fischer, editor, "NBER Macroeconomics Annual 1986, Volume 1" MIT Press (1986)
Handle: RePEc:nbr:nberwo:1898

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  1. Frankel, Jeffrey A, 1979. "On the Mark: A Theory of Floating Exchange Rates Based on Real Interest Differentials," American Economic Review, American Economic Association, vol. 69(4), pages 610-22, September.
  2. Evans, Paul, 1985. "Do Large Deficits Produce High Interest Rates?," American Economic Review, American Economic Association, vol. 75(1), pages 68-87, March.
  3. Paul R. Krugman, 1986. "Is the Strong Dollar Sustainable?," NBER Working Papers 1644, National Bureau of Economic Research, Inc.
  4. Jeffrey Sachs, 1985. "The Dollar and the Policy Mix: 1985," NBER Working Papers 1636, National Bureau of Economic Research, Inc.
  5. Jacob A. Frenkel & Assaf Razin, 1986. "The International Transmission and Effects of Fiscal Policies," NBER Working Papers 1799, National Bureau of Economic Research, Inc.
  6. Plosser, Charles I., 1982. "Government financing decisions and asset returns," Journal of Monetary Economics, Elsevier, vol. 9(3), pages 325-352.
  7. Jacob A. Frenkel & Assaf Razin, 1984. "The International Transmission of Fiscal Expenditures and Budget Deficits in the World Economy," NBER Working Papers 1527, National Bureau of Economic Research, Inc.
  8. Dornbusch, Rudiger, 1976. "Expectations and Exchange Rate Dynamics," Journal of Political Economy, University of Chicago Press, vol. 84(6), pages 1161-76, December.
  9. Meese, Richard A. & Rogoff, Kenneth, 1983. "Empirical exchange rate models of the seventies : Do they fit out of sample?," Journal of International Economics, Elsevier, vol. 14(1-2), pages 3-24, February.
  10. William H. Branson, 1985. "Causes of appreciation and volatility of the dollar," Proceedings, Federal Reserve Bank of Kansas City, pages 33-63.
  11. Martin Feldstein, 1986. "Budget Deficits, Tax Rules, and real Interest Rates," NBER Working Papers 1970, National Bureau of Economic Research, Inc.
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Cited by:
  1. Sebastian Edwards, 1987. "Tariffs, Terms or Trade, and The Real Exchange Rate in and Intertemporal Optimizing Model of the Current Account," UCLA Economics Working Papers 429, UCLA Department of Economics.
  2. Preston J. Miller & William Roberds, 1992. "How little we know about deficit policy effects," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Win, pages 2-11.
  3. Vittorio U. Grilli, 1988. "Fiscal Policies and the Dollar/Pound Exchange Rate: 1870-1984," NBER Working Papers 2482, National Bureau of Economic Research, Inc.
  4. Garima Vasishtha & Taimur Baig & Manmohan S. Kumar & Edda Zoli, 2006. "Fiscal and Monetary Nexus in Emerging Market Economies: How Does Debt Matter?," IMF Working Papers 06/184, International Monetary Fund.
  5. Georgios E. Chortareas & Rebecca L. Driver, 2001. "PPP and the real exchange rate-real interest rate differential puzzle revisited: evidence from non-stationary panel data," Bank of England working papers 138, Bank of England.
  6. Michael Devereux & Thomas A. Wilson, 1989. "International Co-ordination of Macroeconomic Policies: A Review," Canadian Public Policy, University of Toronto Press, vol. 15(s1), pages 20-34, February.
  7. Martin Feldstein & Douglas W. Elmendorf, 1990. "Taxes, Budget Deficits ad Consumer Spending: Some New Evidence," NBER Working Papers 2355, National Bureau of Economic Research, Inc.
  8. Martin Feldstein & Douglas W. Elmendorf, 1989. "Budget Deficits, Tax Incentives and Inflation: A Surprising Lesson From The 1983-84 Recovery," NBER Working Papers 2819, National Bureau of Economic Research, Inc.
  9. Charles Engel & James D. Hamilton, 1989. "Long Swings in the Exchange Rate: Are they in the Data and Do Markets Know It?," NBER Working Papers 3165, National Bureau of Economic Research, Inc.
  10. Chae-Deug Yi, 2003. "An Empirical Analysis of Ricardian Equivalence on Real Exchange Rate and Current Account: Korea," International Economic Journal, Korean International Economic Association, vol. 17(4), pages 61-83.
  11. Peter Hooper, 1989. "Macroeconomic policies, competitiveness, and U.S. external adjustment," International Finance Discussion Papers 347, Board of Governors of the Federal Reserve System (U.S.).
  12. Graciela L. Kaminsky & Michael Klein, 1994. "The Real Exchange Rate and Fiscal Policy During the Gold Standard PeriodEvidence from the United States and Great Britain," NBER Working Papers 4809, National Bureau of Economic Research, Inc.
  13. Kumah, F.Y., 1997. "Common Stochastic Trends and Policy Shocks in the Open Economy: Empirical Essays in International Finance and Monetary Policy," Open Access publications from Tilburg University urn:nbn:nl:ui:12-74321, Tilburg University.
  14. Giancarlo Marini & Giovanni Piersanti, 2003. "Fiscal Deficits and Currency Crises," CEIS Research Paper 15, Tor Vergata University, CEIS.
  15. Mark S Astley & Anthony Garratt, 1998. "Exchange rates and prices: sources of sterling real exchange rate fluctuations 1973-94," Bank of England working papers 85, Bank of England.
  16. Kim, Iljoong & Kim, Inbae, 2008. "Interest group pressure explanations for the yen-dollar exchange rate movements: Focusing on the 1980s," Journal of the Japanese and International Economies, Elsevier, vol. 22(3), pages 364-382, September.

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