Application of Taylor Rule Fundamentals in Forecasting Exchange Rates

Joseph Agyapong
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Joseph Agyapong: Faculty of Business, Economics and Social Sciences, Christian-Albrechts-University of Kiel, Olshausenstr. 40, D-24118 Kiel, Germany

Economies, 2021, vol. 9, issue 2, 1-27

Abstract: This paper examines the effectiveness of the Taylor rule in contemporary times by investigating the exchange rate forecastability of selected four Organisation for Economic Co-operation and Development (OECD) member countries vis-à-vis the U.S. It employs various Taylor rule models with a non-drift random walk using monthly data from 1995 to 2019. The efficacy of the model is demonstrated by analyzing the pre- and post-financial crisis periods for forecasting exchange rates. The out-of-sample forecast results reveal that the best performing model is the symmetric model with no interest rate smoothing, heterogeneous coefficients and a constant. In particular, the results show that for the pre-financial crisis period, the Taylor rule was effective. However, the post-financial crisis period shows that the Taylor rule is ineffective in forecasting exchange rates. In addition, the sensitivity analysis suggests that a small window size outperforms a larger window size.

Keywords: Taylor rule fundamentals; exchange rate; out-of-sample; forecast; random walk; directional accuracy; financial crisis (search for similar items in EconPapers)
JEL-codes: E F I J O Q (search for similar items in EconPapers)
Date: 2021
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:gam:jecomi:v:9:y:2021:i:2:p:93-:d:579027

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