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Taylor Rule Exchange Rate Forecasting during the Financial Crisis

In: NBER International Seminar on Macroeconomics 2012

  • Tanya Molodtsova
  • David H. Papell

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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This chapter was published in:
  • Francesco Giavazzi & Kenneth D. West, 2013. "NBER International Seminar on Macroeconomics 2012," NBER Books, National Bureau of Economic Research, Inc, number giav12-1, December.
  • This item is provided by National Bureau of Economic Research, Inc in its series NBER Chapters with number 12774.
    Handle: RePEc:nbr:nberch:12774
    Contact details of provider: Postal: National Bureau of Economic Research, 1050 Massachusetts Avenue Cambridge, MA 02138, U.S.A.
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