Abstract
This paper re‐examines the relationship between U.S. defense spending and the dollar‐mark exchange rate during the 1960:1 to 1990:4 period. Previous work, under the guise of the “safe haven” argument, finds a cointegrating relationship between real military expenditures, real output and the real dollar‐mark exchange rate. Here, we examine the dynamic time series properties of a cointegrated vector autoregression under a more traditional real exchange rate specification. Through various restrictions placed upon the estimated cointegrating vector, we test specific hypotheses about the long‐run relationships between the variables. Our results reveal that previous work suggesting that military expenditures may significantly affect the real dollar exchange rate value may be misleading.
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