The Real Exchange Rate and the Current Account, 1992-2008

I realized this a.m. that I should have titled this post, "The Bigger Picture".

This graph plots the real exchange rate on a trade-weighted basis (right axis) and monthly goods and services balance in current dollars (left axis) from January 1992 to January 2008. One sees little evidence of a relationship between the real exchange rate and the current account adjustment. If anything, the relationship appears perverse. Indeed, the dollar weakened in real terms on a trade weighted basis between 2002 and 2008. Yet, between 2002 and 2007 the current account deficit widened. It's only since early 2007 that the current account has narrowed. I might also point out that the strengthening of the dollar in the 1990s had little impact on the current account, which remained largely stable until 1998. Maybe this is evidence of a very long lag between exchange rate change and the current account adjustment. Or maybe the two just are not tightly connected causally.