Budget deficits and the value of the dollar: An application of cointegration and error-correction modeling

In this paper we investigate the statistical relation between the U.S. budget deficits and the value of the dollar using cointegration and error-correction techniques. When quarterly data are used over the period 1971-1990, we find no evidence of cointegration. However, when we incorporate 1985 intervention in the foreign exchange market into cointegration analysis, we find strong evidence of cointegration between two variables. The error-correction models yield results that support bidirectional causality between the value of the dollar and budget deficits.