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Wednesday, November 14, 2007

Undervalued Dollar?

Perhaps in an unintentional response to my post, in which I asked how much Tyler would have made if he practiced as his alter-ego preached and shorted T-bonds three years ago, Tyler Cowen writes today:

I know full well that in most sensible intertemporal models the U.S. dollar is overvalued and must fall further to set right the trade balance. But these same intertemporal models don't explain business cycles or unemployment very well (they do at times, but that's it), so why should they explain currency values? Nor do these same macro models command the full loyalty of Krugman and other pessimists in different settings.

I do know that purchasing power parity predicts long swings in exchange rates to some crude extent, and right now I'm dead set against family summer vacation in Europe. So I will accept this dare and assert that the U.S. dollar is undervalued in world currency markets.

Now, as I understand the above, Tyler's argument boils down to his blind intuition that the dollar is undervalued. He says that the same economists who are predicting a downward trend in the dollar are using macro-economic models that don't explain the business cycle, and therefore why should they have any relevance to an analysis of the dollar? That's fair enough, I suppose, but there as at least one economist, Austrian Tyler Cowen, whose analysis is grounded in general models of the business cycle. His model appears to have had some recent predictive success.

Time may of course shed more light on the matter.

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