Debt, deficits and the dollar

This paper examines the relationship between the budget deficit and the trade deficit in the United States by presenting new evidence on the impact effects of debt disturbances on the exchange rate. Based upon estimates of a general two-country portfolio-balance model, we find evidence that increases in the U.S. debt stock have caused an appreciation in the U.S. dollar relative to the German mark and the Canadian dollar over the period 1973II–1987II. Correspondingly, this paper presents evidence on the linkage between the budget deficit and the trade deficit arising through the exchange rate.