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Purchasing power parity and the Taylor rule

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  • Masao Ogaki
  • Bruce E. Hansen
  • Ippei Fujiwara
  • Hyeongwoo Kim

Abstract

It is well-known that there is a large degree of uncertainty around Rogoff's (1996) consensus half-life of the real exchange rate. To obtain a more efficient estimator, we develop a system method that combines the Taylor rule and a standard exchange rate model to estimate half-lives. Further, we propose a median unbiased estimator for the system method based on the generalized method of moments with nonparametric grid bootstrap confidence intervals. Applying the method to real exchange rates of 18 developed countries against the US dollar, we find that most half-life estimates from the single equation method fall in the range of 3 to 5 years with wide confidence intervals that extend to positive infinity. In contrast, the system method yields median-unbiased estimates that are typically shorter than one year with much sharper 95% confidence intervals. Our Monte Carlo simulation results are consistent with an interpretation of these results that the true half-lives are short but long half-life estimates from single equation methods are caused by the high degree of uncertainty of these methods.

Suggested Citation

  • Masao Ogaki & Bruce E. Hansen & Ippei Fujiwara & Hyeongwoo Kim, 2013. "Purchasing power parity and the Taylor rule," AJRC Working Papers 1305, Australia-Japan Research Centre, Crawford School of Public Policy, The Australian National University.
  • Handle: RePEc:csg:ajrcwp:1305
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    File URL: https://crawford.anu.edu.au/pdf/ajrc/wpapers/2013/201305.pdf
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    Cited by:

    1. Maican, Florin G. & Sweeney, Richard J., 2013. "Real exchange rate adjustment in European transition countries," Journal of Banking & Finance, Elsevier, vol. 37(3), pages 907-926.
    2. Kim, Hyeongwoo & Durmaz, Nazif, 2012. "Bias correction and out-of-sample forecast accuracy," International Journal of Forecasting, Elsevier, vol. 28(3), pages 575-586.
    3. Adriana Fernandez & Evan F. Koenig & Alex Nikolsko-Rzhevskyy, 2008. "The relative performance of alternative Taylor rule specifications," Staff Papers, Federal Reserve Bank of Dallas, issue Jun.
    4. Arellano, Manuel & Hansen, Lars Peter & Sentana, Enrique, 2012. "Underidentification?," Journal of Econometrics, Elsevier, pages 256-280.
    5. repec:eee:ecolet:v:158:y:2017:i:c:p:62-66 is not listed on IDEAS
    6. Kim, Hyeongwoo, 2009. "On the usefulness of the contrarian strategy across national stock markets: A grid bootstrap analysis," Journal of Empirical Finance, Elsevier, vol. 16(5), pages 734-744, December.

    More about this item

    JEL classification:

    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • F31 - International Economics - - International Finance - - - Foreign Exchange

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