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The Budget Deficit and the Dollar

  • Martin Feldstein

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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File URL: http://www.nber.org/papers/w1898.pdf
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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 1986
Date of revision:
Publication status: published as Fischer, Stanley (ed.) NBER Macroeconomics Annual 1986. Cambridge, MA: MIT Press, 1986.
Handle: RePEc:nbr:nberwo:1898
Note: EFG PE
Contact details of provider: Postal: National Bureau of Economic Research, 1050 Massachusetts Avenue Cambridge, MA 02138, U.S.A.
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  1. Evans, Paul, 1985. "Do Large Deficits Produce High Interest Rates?," American Economic Review, American Economic Association, vol. 75(1), pages 68-87, March.
  2. Martin Feldstein, 1986. "Budget Deficits, Tax Rules, and real Interest Rates," NBER Working Papers 1970, National Bureau of Economic Research, Inc.
  3. William H. Branson, 1985. "Causes of appreciation and volatility of the dollar," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, pages 33-63.
  4. 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.
  5. Plosser, Charles I., 1982. "Government financing decisions and asset returns," Journal of Monetary Economics, Elsevier, vol. 9(3), pages 325-352.
  6. Jeffrey Sachs, 1985. "The Dollar and the Policy Mix: 1985," NBER Working Papers 1636, National Bureau of Economic Research, Inc.
  7. Jacob A. Frenkel & Assaf Razin, 1986. "The International Transmission and Effects of Fiscal Policies," NBER Working Papers 1799, National Bureau of Economic Research, Inc.
  8. 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.
  9. Dornbusch, Rudiger, 1976. "Expectations and Exchange Rate Dynamics," Journal of Political Economy, University of Chicago Press, vol. 84(6), pages 1161-76, December.
  10. Paul R. Krugman, 1985. "Is the strong dollar sustainable?," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, pages 103-155.
  11. Evans, Paul, 1986. "Is the dollar high because of large budget deficits?," Journal of Monetary Economics, Elsevier, vol. 18(3), pages 227-249, November.
  12. William H. Branson & Jacob A. Frenkel, 1985. "Causes of Appreciation and Volatility of the Dollar with Comment by Jacob Frenkel," NBER Working Papers 1777, National Bureau of Economic Research, Inc.
  13. 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.
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