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Taylor Rule Exchange Rate Forecasting during the Financial Crisis

In: NBER International Seminar on Macroeconomics 2012

Author

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  • Tanya Molodtsova
  • David H. Papell

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.
(This abstract was borrowed from another version of this item.)
(This abstract was borrowed from another version of this item.)

Suggested Citation

  • Tanya Molodtsova & David H. Papell, 2012. "Taylor Rule Exchange Rate Forecasting during the Financial Crisis," NBER Chapters,in: NBER International Seminar on Macroeconomics 2012, pages 55-97 National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberch:12774
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    References listed on IDEAS

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    1. Matteo Iacoviello, 2005. "House Prices, Borrowing Constraints, and Monetary Policy in the Business Cycle," American Economic Review, American Economic Association, pages 739-764.
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    3. Muellbauer, John & Murphy, Anthony, 1997. "Booms and Busts in the UK Housing Market," Economic Journal, Royal Economic Society, vol. 107(445), pages 1701-1727, November.
    4. Hubrich, Kirstin & Tetlow, Robert J., 2015. "Financial stress and economic dynamics: The transmission of crises," Journal of Monetary Economics, Elsevier, pages 100-115.
    5. Radde, Sören, 2015. "Flight to liquidity and the Great Recession," Journal of Banking & Finance, Elsevier, vol. 54(C), pages 192-207.
    6. Hubrich, Kirstin & D’Agostino, Antonello & Cervená, Marianna & Ciccarelli, Matteo & Guarda, Paolo & Haavio, Markus & Jeanfils, Philippe & Mendicino, Caterina & Ortega, Eva & Valderrama, Maria Teresa &, 2013. "Financial shocks and the macroeconomy: heterogeneity and non-linearities," Occasional Paper Series 143, European Central Bank.
    7. Matteo Iacoviello, 2005. "House Prices, Borrowing Constraints, and Monetary Policy in the Business Cycle," American Economic Review, American Economic Association, pages 739-764.
    8. Emanuel Moench & Serena Ng, 2011. "A hierarchical factor analysis of U.S. housing market dynamics," Econometrics Journal, Royal Economic Society, vol. 14(1), pages 1-24, February.
    9. Hubrich, Kirstin & Tetlow, Robert J., 2015. "Financial stress and economic dynamics: The transmission of crises," Journal of Monetary Economics, Elsevier, pages 100-115.
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    Citations

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    Cited by:

    1. Byrne, Joseph P. & Korobilis, Dimitris & Ribeiro, Pinho J., 2016. "Exchange rate predictability in a changing world," Journal of International Money and Finance, Elsevier, pages 1-24.
    2. Buncic, Daniel & Piras, Gion Donat, 2016. "Heterogeneous agents, the financial crisis and exchange rate predictability," Journal of International Money and Finance, Elsevier, pages 313-359.
    3. Ahmed, Jameel & Straetmans, Stefan, 2015. "Predicting exchange rate cycles utilizing risk factors," Journal of Empirical Finance, Elsevier, pages 112-130.
    4. Gokcen Ogruk, 2014. "Is Implied Taylor Rule Interest Rate Applicable as a Carry Trade Strategy?," International Journal of Economics and Financial Issues, Econjournals, pages 909-919.
    5. Inoue, Atsushi & Jin, Lu & Rossi, Barbara, 2017. "Rolling window selection for out-of-sample forecasting with time-varying parameters," Journal of Econometrics, Elsevier, pages 55-67.
    6. repec:eee:reveco:v:51:y:2017:i:c:p:60-81 is not listed on IDEAS
    7. Ince, Onur & Molodtsova, Tanya & Papell, David H., 2016. "Taylor rule deviations and out-of-sample exchange rate predictability," Journal of International Money and Finance, Elsevier, vol. 69(C), pages 22-44.
    8. Atsushi Inoue & Lu Jin & Barbara Rossi, 2014. "Rolling window selection for out-of-sample forecasting with time-varying parameters," Economics Working Papers 1435, Department of Economics and Business, Universitat Pompeu Fabra, revised Apr 2016.
    9. Inoue, Atsushi & Jin, Lu & Rossi, Barbara, 2017. "Rolling window selection for out-of-sample forecasting with time-varying parameters," Journal of Econometrics, Elsevier, pages 55-67.

    More about this item

    JEL classification:

    • C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes
    • F31 - International Economics - - International Finance - - - Foreign Exchange

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