Taylor Rule Exchange Rate Forecasting During the Financial Crisis

Tanya Molodtsova · David H. Papell

26 citations0/0 files storedNational Bureau of Economic Research

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Monetary Policy and Economic Impact Financial Markets and Investment Strategies Forecasting Techniques and Applications

Abstract

This paper evaluates out-of-sample exchange rate predictability of Taylor rule models, where the central bank sets the interest rate in response to inflation and either the output or the unemployment gap, for the euro/dollar exchange rate with real-time data before, during, and after the financial crisis of 2008-2009.While all Taylor rule specifications outperform the random walk with forecasts ending between 2007:Q1 and 2008:Q2, only the specification with both estimated coefficients and the unemployment gap consistently outperforms the random walk from 2007:Q1 through 2012:Q1.Several Taylor rule models that are augmented with credit spreads or financial condition indexes outperform the original Taylor rule models.The performance of the Taylor rule models is superior to the interest rate differentials, monetary, and purchasing power parity models.

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References

1993Discretion versus policy rules in practice 1994Comparing Predictive Accuracy 1995Comparing Predictive Accuracy 1996Asymptotic Inference about Predictive Ability 1995Some Empirical Evidence on the Effects of Shocks to Monetary Policy on Exchange Rates 2001A real-time data set for macroeconomists 2009Credit Spreads and Monetary Policy 2006Asymptotics for out of sample tests of Granger causality

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2017The Role of Technical Indicators in Exchange Rate Forecasting 2021Data Science for Economics and Finance 2015Heterogeneous agents, the financial crisis and exchange rate predictability 2014Can structural change explain the Meese-Rogoff puzzle?2018The real exchange rate in Taylor rules: A Re-Assessment 2021What is on the ECB’s mind? Monetary policy before and after the global financial crisis

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