The Budget Deficit and the Dollar

62 Pages Posted: 5 Jul 2004 Last revised: 10 Sep 2010

See all articles by Martin S. Feldstein

Martin S. Feldstein

National Bureau of Economic Research (NBER) (deceased); Harvard University (deceased)

Date Written: April 1986

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.

Suggested Citation

Feldstein, Martin S., The Budget Deficit and the Dollar (April 1986). NBER Working Paper No. w1898, Available at SSRN: https://ssrn.com/abstract=304108

Martin S. Feldstein (Contact Author)

National Bureau of Economic Research (NBER) (deceased)

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Harvard University (deceased)

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