Thomas Klitgaard, Paolo Pesenti, and Linda Wang

Oil prices and the exchange rate of the U.S. dollar against the euro have often moved together over the past decade or so, but it is not at all clear why they should. The standard interpretation of oil price movements as a response to global oil supply and demand shifts makes it unlikely that the correlation stems from the dollar’s effect on oil prices. In addition, the notorious difficulty in predicting currency moves makes it hard to believe that oil prices dictate the dollar’s value. Improbability aside, however, in this blog post we document the tendency for the value of the dollar to rise relative to European currencies when oil prices fall, and we consider a possible explanation for the correlation.