Originally Posted by kevincure

I work at the Federal Reserve and am quite familiar with how policy is being set. There is very little concern about exchange rates, and certainly nothing like a deliberate "export-driven policy" as an earlier poster mentioned. In general, PPP, or the equalization of prices across economies, tends to hold in the long run (say, 5 to 10 years). Over shorter periods, it's very difficult to know what moves exchange rates.

The only way prices will reequalize is a) higher US inflation, or b) strengthening of the dollar. The Fed spends 99% of its energy limiting inflation (and 1%, as seen this week, in preventing liquidity problems), so I would bet on b) and not a). The dollar was very, very strong in 2001 and 2002, and we're unlikely to return to that point. But something along the lines of
$1.20 - Euro
110 Yen - $
$1.25CAN - $
6 RMB - $
1.70 sterling - $
.75 AUD - $
seems fairly plausible for me a few years out.

Currency is a huge mystery. There is basically a zero chance of US default, so standard parity equations would imply that investors see a much higher real interest rate in Europe vs. the US over the next few years. Inflation is very similar in the Eurozone, Uk and US, so this implies that Europe will see much higher nominal growth than the US for the next few years. I just don't see this happening.

Finally, one more note on "export-led growth". Exports matter is small, trade-heavy countries. In the US, the exports part of GDP is very small (well under 10%), so you'd be hard-pressed to see a large gain in GDP from export growth alone.

Ok, one more note: A lot of the differential (not vs. the Euro, but certainly against the CAD) recently has been driven by huge growth in raw material prices. Canada is something like 15% minerals. The US does not have a large (relative to GDP) export industry in things like oil, nickel, etc., so some of these currency gains against the US look like old-fashioned "Dutch Disease".