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 per iod 1971-1990, we find no evidence of cointegration. However, when we incorporate 1985 intervention in the foreign exchange market into coin tegration analysis, we find strong evidence of cointegration between t wo variables. The error-correction models yield results that support b idirectional causality between the value of the dollar and budget defi cits.