Description
Title: Fundamentals of the Taylor Rule Applied to Exchange Rate Forecasting
Abstract: In this paper, the forecastability of exchange rates for a sample of four OECD member countries relative to the US is investigated in order to assess the applicability of the Taylor rule in the modern era. It uses non-drift random walks and various Taylor rule models with monthly data from 1995 to 2019. Analyzing the pre- and post-financial crisis periods for forecasting exchange rates shows the model’s effectiveness. The symmetric model without interest rate smoothing, heterogeneous coefficients, and a constant has the best performance, according to the results of the out-of-sample forecast. The outcomes, in particular, demonstrate that the Taylor rule worked during the time leading up to the financial crisis. However, the Taylor rule is ineffective at predicting exchange rates, as evidenced by the post-financial crisis period. A smaller window size performs better than a larger window size, according to the sensitivity analysis.
Keywords: Taylor rule fundamentals; exchange rate; out-of-sample; forecast; random walk; direc- tional accuracy; financial crisis
Paper Quality: SCOPUS / Web of Science Level Research Paper
Subject: Economics
Writer Experience: 20+ Years
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