May 29, 2002

Judging by the op-ed page of the Wall Street Journal, the U.S. dollar has become a hot topic of discussion. At issue is the type of signal being provided by the fluctuations in its foreign exchange value. Two competing hypotheses are being discussed in the press. One group of economists argues that the recent decline in the dollar is a harbinger of inflation in months to come. Another group argues the weaker dollar is a harbinger of lower rates of return in the U.S. relative to the rest of the world. The funny thing about these two apparently different views of the world is that they are special cases of a more general framework. That framework is that the exchange rate reflects differences in nominal rates of returns between two regions/countries. (full article attached)

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