Taylor Rule Exchange Rate Forecasting During the Financial Crisis

41 Pages Posted: 30 Aug 2012  

Tanya Molodtsova

Emory University

David H. Papell

University of Houston - Department of Economics

Date Written: August 2012

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.

Suggested Citation

Molodtsova, Tanya and Papell, David H., Taylor Rule Exchange Rate Forecasting During the Financial Crisis (August 2012). NBER Working Paper No. w18330. Available at SSRN: https://ssrn.com/abstract=2138705

Tanya Molodtsova (Contact Author)

Emory University ( email )

201 Dowman Drive
Atlanta, GA 30322
United States

HOME PAGE: http://userwww.service.emory.edu/~tmolodt/

David H. Papell

University of Houston - Department of Economics ( email )

Houston, TX 77204-5882
United States

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