I think that President Bush has a good insight in focusing on long-term growth as a determinant of the dollar’s path. In particular, I want to highlight the fact that the dollar’s decline began before the Fed starting slashing interest rates. In Figure 2, I plot the real value of the dollar against major currencies and the US-euro area real interest differential (the interbank rate minus lagged one year inflation). Even as the US-euro area real interest differential increased in 2005-06, the dollar was declining.
In other words, the dollar devaluation is not entirely explained by the interest rate effects from the Federal Reserve’s easy monetary policy. Menzie also notes a portfolio balance effect, an effect from at least the perception that wealth is declining, and trend GDP effects. But let’s read on as to why President Bush might want a stronger dollar:
Q: You mentioned that one of the reasons that’s driving up the price of oil is the dollar. You have said that you are for a strong dollar. Do we have a strong dollar now?
Bush: We have a dollar that’s adjusting, and I am for a strong dollar. One reason I am for a strong dollar is because I want, you know, people to — I think it helps deal with inflation. And you’re right, the weakening dollar has affected our capacity to be able to purchase energy. I mean, we’re dependent on energy from overseas. Our dollar doesn’t buy as many barrels of oil as it used to, and so therefore it’s more expensive for the American people. And that’s why I’m for a strong dollar; one reason.
I suspect Dean Baker would not agree that dollar devaluation is what is causing high oil prices:
Listening to NPR heard this morning I heard NPR mislead their listeners on this issue twice in less than an hour. That’s pretty good in the misinformation department. The first time was in their top of the hour news. They told listeners that the dollar was falling in world currency markets. Then they told audiences that because oil is priced in dollars, the falling dollar meant higher oil prices. This should have led to a huge “huh?” from NPR’s audience. A lower value of the dollar means that it will take more dollars to buy oil regardless of what currency it is priced. In fact, we would have to pay more dollars for oil even if it were priced in pig intestines.
Bush also seems to agree with Lawrence Kudlow on the desire for a stronger dollar via tighter monetary policy but I have argued that such a policy would tend to lower net export demand making a lot of bad things even worse. If Bush, Kudlow, and McCain want the GOP agenda to be a strong dollar campaign that would lower net export demand and hence make the upcoming recession worse, maybe the Democratic nominee should strongly disagree.