Thursday, March 18, 2010

The Over Valued Dollar?

. Thursday, March 18, 2010

As Congress pressures the administration to label China a currency manipulator in the Treasury's semi-annual report on exchange rates, I thought it might be useful to look at the dollar's exchange rate on a real trade-weighted basis. The index above is the dollar's real effective exchange rate index (narrow) as calculated by the Bank for International Settlements. This narrow index does not include China, but is almost perfectly correlated with the BIS's broad index which does and weights China about 17 percent. I use the narrow because the broad index extends back only to 1994.


This index provides little indication that the dollar is over valued in real terms. Clearly the dollar was over valued at the height of the housing bubble. Just as clearly, the dollar has fallen subsequently. Although the dollar strengthened in 2008 and early 2009 as a consequence of the flight to safety in the midst of the financial crisis, it currently rests quite close to its post-Bretton Woods era floor.

It is not obvious therefore that the current account imbalance is a consequence of an over valued dollar and it is not obvious that a currency realignment is the appropriate corrective. I know that American legislators have little incentive to care about the macroeconomic perspective and that their motivation in pressing China for change reflects the microeconomic consequences (relative prices) for individual producers based in their districts. Their behavior is not particularly puzzling. What puzzles me is what Krugman is thinking.

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The Over Valued Dollar?
 
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