Taylor Rule Exchange Rate Forecasting During the Financial Crisis

Tanya Molodtsova () and David Papell

No 18330, NBER Working Papers from National Bureau of Economic Research, Inc

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.

JEL-codes: C22 F31 (search for similar items in EconPapers)
Date: 2012-08
New Economics Papers: this item is included in nep-cba, nep-for, nep-mac and nep-mon
Note: IFM
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Published as Tanya Molodtsova & David H. Papell, 2013. "Taylor Rule Exchange Rate Forecasting during the Financial Crisis," NBER International Seminar on Macroeconomics, University of Chicago Press, vol. 9(1), pages 55 - 97.
Published as Taylor Rule Exchange Rate Forecasting during the Financial Crisis , Tanya Molodtsova, David H. Papell. in NBER International Seminar on Macroeconomics 2012 , Giavazzi and West. 2013

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