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Taylor rule equilibrium exchange rates and nonlinear mean reversion

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  • Joscha Beckmann
  • Wolfram Wilde

Abstract

This article analyses the validity of the Taylor rule exchange rate model from a new perspective. In a first step, a model-based exchange rate is derived for Germany and Japan following the approach by Engel and West (2006). This model-based exchange rate is determined by the fundamentals of the Taylor rule exchange rate model and treated as the equilibrium exchange rate. Following this, exponential smooth transition regressive (ESTR) models are fitted to tackle the question of whether the real exchange rate shows mean reverting behaviour towards this equilibrium exchange rate. In particular for Germany, the results indeed suggest that real exchange rates adjust and mean revert much faster in case of large deviations from the equilibrium exchange rate.

Suggested Citation

  • Joscha Beckmann & Wolfram Wilde, 2013. "Taylor rule equilibrium exchange rates and nonlinear mean reversion," Applied Financial Economics, Taylor & Francis Journals, vol. 23(13), pages 1097-1107, July.
    • Handle: RePEc:taf:apfiec:v:23:y:2013:i:13:p:1097-1107
    DOI: 10.1080/09603107.2013.788780
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    1. Richard Clarida & Daniel Waldman, 2007. "Is Bad News About Inflation Good News for the Exchange Rate?," NBER Working Papers 13010, National Bureau of Economic Research, Inc.
    2. Kenneth S. Rogoff & Vania Stavrakeva, 2008. "The Continuing Puzzle of Short Horizon Exchange Rate Forecasting," NBER Working Papers 14071, National Bureau of Economic Research, Inc.
    3. Michael, Panos & Nobay, A Robert & Peel, David A, 1997. "Transactions Costs and Nonlinear Adjustment in Real Exchange Rates: An Empirical Investigation," Journal of Political Economy, University of Chicago Press, vol. 105(4), pages 862-879, August.
    4. Lucio Sarno & Giorgio Valente & Hyginus Leon, 2006. "Nonlinearity in Deviations from Uncovered Interest Parity: An Explanation of the Forward Bias Puzzle," Review of Finance, European Finance Association, vol. 10(3), pages 443-482, September.
    5. John B. Taylor, 2007. "Housing and monetary policy," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, pages 463-476.
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    Cited by:

    1. Chen, Chuanglian & Yao, Shujie & Ou, Jinghua, 2017. "Exchange rate dynamics in a Taylor rule framework," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 46(C), pages 158-173.
    2. Christina Anderl & Guglielmo Maria Caporale, 2022. "Exchange rate parities and Taylor rule deviations," Empirical Economics, Springer, vol. 63(4), pages 1809-1835, October.
    3. Olumuyiwa Tolulope Apanisile & Olusola Mathew Oloba, 2020. "Asymmetric effect of exchange rate changes on cross-border trade in Nigeria," Future Business Journal, Springer, vol. 6(1), pages 1-9, December.

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