In this paper, we apply co-integration and error correction modelling to the annual data on government deficit, interest rate, current account deficit of balance of payments, exchange rate, consumption expenditure, and government debt in Germany and the U.K. for 1950-2002. There is evidence that interest rate, current account deficit and debt increase with government deficit in both countries and
... [Show full abstract] there exist co-integrated relations between deficit and interest rate and between current account deficit and government deficit in both countries. The years of the breakdown of the Bretton Woods arrangement and the setting up of the European Monetary System affect stationarity and co-integration properties of variables in both economies. There are statistically significant estimates of coefficients of the error correction variable in Germany and in the UK but the speed of adjustment is mentionable only for current account deficit and for consumption in Germany and only for debt in the UK. The evidence on bivariate causality from deficit, therefore, also exists in these three cases.
