James Hamilton submits: Although movements in the value of the dollar are one factor contributing to recent changes in the dollar price of oil, I do not believe they are the most important factor. Here I review some of the evidence that persuades me of this. There are a variety of reasons why oil prices and the exchange rate might move together. A drop in U.S. interest rates relative to Europe was likely one factor that contributed to both the increase in the price of oil and the increase in the value of the euro earlier this year. Over the last few weeks, expectations of weaker European output helped the dollar to gain against the euro and also brought oil prices down. Yet another example, and the one people often think of first, would be if there is a higher inflation rate in the U.S. than Europe. In that case we might expect to see an increase in the price of oil that exactly equals (in percentage terms) the decrease in the value of the dollar.Complete Story »