can oil prices forecast exchange rates an empirical analysis of the relationship between commodity prices and exchange rates we show the existence of a very short term relationship at the daily frequency between changes in the price of a country s major commodity export and changes in its nominal exchange rate the relationship appears to be robust and to hold when we use contemporaneous realized commodity price changes in our regression however when we use lagged commodity price changes the predictive ability is ephemeral mostly appearing after instabilities have been appropriately taken into account

monetary policy in open economies practical perspectives for pragmatic central bankers this paper reviews and interprets some of the key policy implications that flow from a class of dsge models for optimal monetary policy in the open economy the framework suggests that good macroeconomic outcomes in open economies are possible by focusing inflation targeting that is implemented by a taylor type rule a rule that in equilibrium is reflected in the exchange rate as an asset price optimal monetary policy will not be able deliver a stationary stable nominal exchange rate let alone a fixed exchange rate or one that remains inside a target zone because absent a commitment device optimal monetary can t deliver a stationary domestic price level another feature in the data for inflation targeting countries that is consistent with monetary policy via taylor type rule is that it will tend push the nominal exchange rate in the opposite direction from ppp in response to an inflation shock the bad news god news result of clarida and waldman 2008 is bad news about inflation good news for the exchange rate in john campbell ed asset prices and monetary policy chicago university of chicago press clarida and waldman 2014 bad news about inflation is good news for the nominal exchange rate under optimal monetary policy dsge theory and a decade of empirical evidence this is so even though in the long run of these models the nominal exchange rate must in expectation obey ppp

rational expectations changing monetary policy rules and real exchange rate dynamics abstract this paper reexamines the explanatory power of taylor rule fundamentals for real exchange rate determination we assume the agents know the time varying parameters in central bank policy rules the empirical results suggest that a monetary policy rule with regime switching is better able to explain the real deutschemark dollar exchange rate from 1976 to 1998 compared with a fixed regime monetary policy rule the findings show the importance of accounting for the expectation formation effect in changing policy rules as emphasized by the lucas critique ignoring these effects can undermine the value of the rational expectations models

some empirical evidence on the effects of shocks to monetary policy on exchange rates this paper investigates the effects of shocks to u s monetary policy on exchange rates we consider three measures of these shocks orthogonalized shocks to the federal funds rate orthogonalized shocks to the ratio of nonborrowed to total reserves and changes in the romer and romer index of monetary policy in sharp contrast to the literature we find substantial evidence of a link between monetary policy and exchange rates specifically according to our results a contractionary shock to u s monetary policy leads to i persistent significant appreciations in u s nominal and real exchange rates and ii significant persistent deviations from uncovered interest rate parity in favor of u s interest rates

third country effects on the exchange rate abstract predictive regressions for bilateral exchange rates are typically run on variables from the associated bilateral pairs of countries these regressions characteristically have low explanatory power which leaves room for an omitted variables interpretation we test whether these omitted variables are from third countries when third country macro factors are added to bilateral exchange rate regressions they enter significantly and increase the adjusted r 2 a three country exchange rate model illustrates potential channels for third country spillovers to affect the bilateral rate

model uncertainty and exchange rate volatility this article proposes an explanation for shifts in the volatility of exchange rate returns agents are uncertain about the true data generating model and deal with this uncertainty by making inference on the models and their parameters approach i call model learning model learning may lead agents to focus excessively on a subset of fundamental variables consequently exchange rate volatility is determined by the dynamics of these fundamentals and changes as agents alter models i investigate the empirical relevance of model learning and find that the change in volatility of gbp usd in 1993 was triggered by a shift between models

exchange rate predictability in a changing world an expanding literature articulates the view that taylor rules are helpful in predicting exchange rates in a changing world however taylor rule parameters may be subject to structural instabilities for example in the aftermath of the global financial crisis this paper forecasts exchange rates using taylor rules with time varying parameters tvp estimated by bayesian methods focusing on the data from the crisis we improve upon the random walk for at least half and for as many as seven out of 10 of the currencies considered results are stronger when we allow the tvp of the taylor rules to differ between countries

interest rates and the exchange rate a non monotonic tale abstract for over 30 years the empirical international finance literature has been unable to detect a clear systematic relationship between interest rates and the nominal exchange rate we take a fresh look at the data and uncover a new stylized fact for a cross section of countries the relationship between the exchange rate and short term interest rates is non monotonic small increases in the nominal interest rate appreciate the currency whereas larger increases depreciate the currency we develop a model that explains this stylized fact based on the interaction of three effects higher interest rates increase money demand and hence appreciate the currency but also raise the fiscal deficit and depress output both of which tend to depreciate the currency we provide cross country evidence for the presence of these effects in the data

trend fundamentals and exchange rate dynamics we estimate a multivariate unobserved components stochastic volatility model to explain the dynamics of a panel of six exchange rates against the us dollar the empirical model is based on the assumption that both countries monetary policy strategies may be well described by taylor rules with a time varying inflation target a time varying natural rate of unemployment and interest rate smoothing the estimates closely track major movements along with important time series properties of real and nominal exchange rates across all currencies considered the model generally outperforms a benchmark model that does not account for changes in trend inflation and trend unemployment authors abstract

factor models and time varying parameter framework for forecasting exchange rates and inflation a survey a survey of models used for forecasting exchange rates and inflation reveals that the factor based and time varying parameter or state space models generate superior forecasts relative to all other models this survey also finds that models based on taylor rule and portfolio balance theory have moderate predictive power for forecasting exchange rates the evidence on the use of bayesian model averaging approach in forecasting exchange rates reveals limited predictive power but strong support for forecasting inflation overall the evidence overwhelmingly points to the context of the forecasts relevance of the historical data data transformation choice of the benchmark selected time horizons sample period and forecast evaluation methods as the crucial elements in selecting forecasting models for exchange rate and inflation

exchange rate puzzles and distorted beliefs abstract we propose a new explanation for the foreign exchange forward premium and delayed overshooting puzzles we show that both puzzles arise from a systematic distortion in investors beliefs about the interest rate process accordingly the forward premium is always a biased predictor of future depreciation the bias can be so severe as to lead to negative coefficients in the fama regression delayed overshooting may or may not occur depending upon the persistence of interest rate innovations and the degree of misperception we document empirically the extent of this distortion using survey data for g 7 countries against the u s and find that it is strong enough to account for these irregularities

taylor rules and the euro this paper uses real time data to analyze whether the variables that normally enter central banks interest ratesetting rules which we call taylor rule fundamentals can provide evidence of out of sample predictability for the united states dollar euro exchange rate from the inception of the euro in 1999 to the end of 2007 the major result of the paper is that the null hypothesis of no predictability can be rejected against an alternative hypothesis of predictability with taylor rule fundamentals for a wide variety of specifications that include inflation and a measure of real economic activity in the forecasting regression we also present less formal evidence that with real time data the taylor rule provides a better description of ecb than of fed policy during this period while the evidence of predictability is only found for specifications that do not include the real exchange rate in the forecasting regression the results are robust to whether or not the coefficients on inflation and the real economic activity measure are constrained to be the same for the u s and the euro area and to whether or not there is interest rate smoothing the evidence of predictability is stronger for realtime than for revised data about the same with inflation forecasts as with inflation rates and weakens if output gap growth is included in the forecasting regression bad news about inflation and good news about real economic activity both lead to out of sample predictability through forecasted exchange rate appreciation

trade intensity and purchasing power parity abstract in this paper we seek to contribute to the ppp literature by presenting evidence of a link between trade intensity and exchange rate dynamics we first establish a negative effect of trade intensity on exchange rate volatility using panel regressions with distance as an instrument to correct for endogeneity we also estimate a nonlinear model of mean reversion to compute half lives of deviations of bilateral exchange rates from the levels dictated by relative ppp and find these half lives to be significantly shorter for high trade intensity currency pairs this result does not appear to be driven by central bank intervention finally we show that conditioning on ppp may help improve the performance of popular currency trading strategies such as the carry trade especially for low trade intensity currency pairs

learning and capacity expansion under demand uncertainty a competitive dynamic model of entry into a new industry is set up and both its positive and normative aspects are studied the main assumptions are that entry is sequential that it occurs under imperfect information on the size of the market and that better information becomes available as time goes on the gradual improvement in information is due to the fact that later waves of entrants are able to observe the profitability of earlier entrants the major results reported here under suitable restrictions are that the equilibrium rate of entry is monotonically decreasing over time and that at any given point in time it is smaller than the socially optimal one when a new market opens as a result of a product being newly invented for instance or when an existing market starts to expand uncertainty with respect to its size is likely to prevail as a result of this uncertainty entry of firms into such markets typically will occur in waves some firms will enter initially while others will wait to see the consequences of that initial entry if the experience of early entrants is favourable entry will continue otherwise entry will cease hence with the introduction of a new product two phases are associated the growth phase typified by positive operating profits for existing firms and expansion of productive capacity due to entry of new firms and the mature phase typified by erosion of profits and fixed total productive capacity empiricists estimating the time pattern of investments during the growth phase have found an s shaped diffusion curve see mansfield 1986 and gort and klepper 1982 the purpose of the present paper is to theoretically characterize these time patterns and to investigate their welfare properties any attempt to model the type of entry described above must account for differences in both entry dates and resultant earnings in other words the theory must explain why the realized earnings of different cohorts of firms are not equal often such ex post differences are reconciled by assuming heterogeneity with respect to some latent underlying characteristic managerial ability for instance and attributing differences in earnings to differences in that characteristic in this paper instead earning differentials are attributable to luck only ex ante all firms are technologically identical and equally capable of forecasting market prospects and rationally acting upon those forecasts ex post some firms turn out to have entered at the right time and are for that reason more profitable the model developed in this paper analyzes a parametric example of a sequential entry problem in which the uncertainty over market size is gradually resolved over time in a bayesian setting in an environment of perfect competition and constant returns toscale a free entry equilibrium concept is introduced and the aggregate implications of the time path of investments are derived i then compare this actual time path to the optimum this comparison is interesting because the equilibrium is analysed under the

optimal monetary policy in a currency area abstract this paper investigates how monetary policy should be conducted in a two region general equilibrium model with monopolistic competition and price stickiness this framework delivers a simple welfare criterion based on the utility of the consumers that can be used to evaluate monetary policy in a currency area if the two regions share the same degree of nominal rigidity the terms of trade are completely insulated from monetary policy and the optimal outcome is obtained by targeting a weighted average of the regional inflation rates these weights coincide with the economic sizes of the region if the degrees of rigidity are different the optimal plan implies a high degree of inertia in the inflation rate but an inflation targeting policy in which higher weight is given to the inflation in the region with higher degree of nominal rigidity is nearly optimal

price stability in open economies this paper studies the conditions under which price stability is the optimal policy in a two country open economy model with imperfect competition and price stickiness special conditions on the levels of country specific distortionary taxation and the intratemporal and intertemporal elasticities of substitution need to be satisfied these restrictions apply to both cooperative and non cooperative settings most importantly we show that cooperative and non cooperative solutions do not coincide despite market completeness and producer currency pricing in this framework our analysis suggests a role for international policy coordination

fundamentals and exchange rate prediction revisited this paper measures latent fundamental exchange rates with independent component based rates constructed from a cross section of exchange rates and then uses their deviations from exchange rates to forecast empirical results indicate that the independent component based model and its taylor rule and purchasing power parity augmented models are superior to the random walk in predicting exchange rates these results are robust to several scenarios and are likely to be observed if the us sources and the recursive scheme are applied our results reveal that information regarding the third moment of exchange rate changes is helpful to explain exchange rate movements

optimal monetary policy in open versus closed economies an integrated approach in clarida et al 1999 hereafter cgg we presented a normative analysis of monetary policy within a simple optimization based closedeconomy framework we derived the optimal policy rule and among other things characterized the gains from commitment also we made precise the implications for the kind of instrument feedback rule that a central bank should follow in practice in this paper we show how our analysis extends to the case of a small open economy openness complicates the problem of monetary management to the extent the central bank must take into account the impact of the exchange rate on real activity and inflation how to factor the exchange rate into the overall design of monetary policy accordingly becomes a central consideration here we show that under certain conditions the monetary policy design problem for the small open economy is isomorphic to the problem of the closed economy that we considered earlier hence all our qualitative results for the closed economy carry over to this case openness does affect the parameters of the model suggesting quantitative implications though the general form of the optimal interest rate feedback rule remains the same as in the closedeconomy case for example how aggressively a central bank should adjust the interest rate in response to inflationary pressures depends on the degree of openness in addition openness gives rise to an important distinction between domestic inflation and consumer price inflation as defined by the cpi to the extent that there is perfect exchange rate pass through we find that the central bank should target domestic inflation and allow the exchange rate to float despite the impact of the resulting exchangerate variability on the cpi kosuki aoki 1999 gali and tommaso monacelli 2000

new directions for stochastic open economy models the paper develops a simple stochastic new open economy macroeconomic model based on sticky nominal wages explicit solution of the wage setting problem under uncertainty allows one to analyze the effects of the monetary regime on welfare expected output and the expected terms of trade despite the potential interplay between imperfections due to sticky wages and monopoly the optimal monetary policy rule has a closed form solution to motivate our model we show that observed correlations between terms of trade and exchange rates are more consistent with our traditional assumptions about nominal rigidities than with a popular alternative based on local currency pricing 2000 elsevier science b v all rights reserved

threshold behavior and aggregate fluctuation this paper concerns a propagation mechanism in an economy where many individuals follow a threshold rule and interact with a positive feedback we derive an asymptotic distribution of the propagation size when the number of the agents tends to infinity the propagation distribution exhibits a slower convergence to a deterministic value than it would if the agents followed a smooth adjustment policy this gives rise to significant aggregate fluctuations in a finite lumpy adjusting economy even when the agents are hit by small independent shocks

structural breaks in taylor rule based exchange rate models evidence from threshold time varying parameter models in this note we develop a taylor rule based empirical exchange rate model for eleven major currencies that endogenously determines the number of structural breaks in the coefficients using a constant parameter specification and a standard time varying parameter model as competitors reveals that our flexible modeling framework yields more precise density forecasts for all major currencies under scrutiny over the last 24 years

overturning mundell fiscal policy in a monetary union central to ongoing debates over the desirability of monetary unions is a supposed trade off outlined by mundell 1961 a monetary union reduces transactions costs but renders stabilization policy less effective if shocks across countries are sufficiently correlated then according to this argument delegating monetary policy to a single central bank is not very costly and a monetary union is desirable this paper explores this argument in a setting with both monetary and fiscal policies in an economy with monetary policy alone we confirm the presence of the trade off and find that indeed a monetary union will not be welfare improving if the correlation of national shocks is too low however fiscal interventions by national governments combined with a central bank that has the ability to commit to monetary policy overturn these results in equilibrium such a monetary union will be welfare improving for any correlation of shocks

the new open economy macroeconomics of government debt in this paper we introduce an overlapping generations structure of the blanchard type in a new open economy macroeconomics model this allows us to study a wider range ofscal shocks compared to the traditional mundell fleming and to the baseline redux models one important policy implication of our model is that the tax cut imple mented in the us in 2001 might have contributed to the appreciation of the dollar vis a vis the euro in contrast the imposition ofscal constraint such as the golden rule proposed by the uk government can have opposite exchange rate e ects

testing long horizon predictive ability with high persistence and the meese rogoff puzzle a well known puzzle in the international finance literature is that a random walk predicts exchange rates better than economic models meese and rogoff 1983a b and 1988 this paper offers a potential explanation for this finding when exchange rates and fundamentals are highly persistent long horizon forecasts of economic models are asymptotically biased by the estimation error in the parameter that measures the persistence when this bias outweighs the benefits from exploiting economic information the random walk model will forecast better this happens even if the economic model is the true data generating process the reason is that a random walk model imposes a unit root rather than estimates it the paper thus proposes a test for equal predictive ability in the presence of highly persistent variables when applied to the meese rogoff exercise this test shows that the poor forecasting ability of economic models does not imply that the models are not a good description of the data

learning and complementarities in speculative attacks we study a model where the aggregate trading of currency speculators reveals new information to the central bank and affects its policy decision we show that the learning process gives rise to coordination motives among speculators leading to large currency attacks and introducing non fundamental volatility into exchange rates and policy decisions we show that the central bank can improve the ex ante effectiveness of its policy by committing to put a lower weight ex post on the information from the market and that transparency may either increase or decrease the effectiveness of learning from the market depending on how it is implemented

global implications of self oriented national monetary rules author s obstfeld maurice rogoff kenneth abstract it is well known that if international linkages are relatively small the potential gains to international monetary policy coordination are typically quite limited but what if goods and financial markets are tightly linked is it then problematic if countries unilaterally design their institutions for monetary stabilization are the stabilization gains from having separate currencies largely squandered in the absence of effective international monetary coordination we argue that under plausible assumptions the answer is no unless risk aversion is very high lack of coordination in rule setting is a second order problem compared to the overall gains from monetary policy stabilization

exchange rate forecasting on a napkin abstract this paper shows that there are two regularities in foreign exchange markets in advanced countries with flexible regimes first real exchange rates are mean reverting as implied by the purchasing power parity model second the adjustment takes place via nominal exchange rates these features of the data can be exploited even on the back of a napkin to generate nominal exchange rate forecasts that outperform the random walk the secret is to avoid estimating the pace of mean reversion and assume that relative prices are unchanged direct forecasting panel data techniques and non linear models can outperform the random walk but fail to beat this simple calibrated model

monetary policy rules based on real time data this paper examines the magnitude of informational problems associated with the implementation and interpretation of simple monetary policy rules using taylor s rule as an example i demonstrate that real time policy recommendations differ considerably from those obtained with ex post revised data further estimated policy reaction functions based on ex post revised data provide misleading descriptions of historical policy and obscure the behavior suggested by information available to the federal reserve in real time these results indicate that reliance on the information actually available to policy makers in real time is essential for the analysis of monetary policy rules

exchange rate forecasts and expected fundamentals using a large panel of individual professionals forecasts this paper demonstrates that good exchange rate forecasts are related to a proper understanding of fundamentals specifically good interest rate forecasts this relationship is robust to individual fixed effects and further controls reassuringly the relationship is stronger during phases when the impact from fundamentals is more obvious e g when exchange rates substantially deviate from their ppp values finally forecasters largely agree that an interest rate increase relates to a currency appreciation but only good forecasters get expected interest rates right

fiscal stabilization with partial exchange rate pass through this paper examines the role of fiscal stabilization policy in a two country framework that allows for a general degree of exchange rate pass through i derive analytical solutions for optimal monetary and fiscal policy which are shown to depend on the degree of passthrough in the case of partial pass through an optimizing policy maker uses counter cyclical fiscal stabilization in addition to monetary stabilization however in the extreme cases of complete or zero pass through the fiscal stabilization instrument is not employed there is also no additional gain from the fiscal instrument in the case of coordination between the two countries these results are due to the specific way the optimal fiscal policy rule affects marginal costs rather than being a substitute for monetary policy fiscal policy complements it by increasing the correlation of the marginal cost terms within and across countries this in turn makes monetary policy more effective at stabilizing them

changing monetary policy rules learning and real exchange rate dynamics when the exchange rate is priced by uncovered interest parity and central banks set nominal interest rates according to a reaction function such as the taylor rule the real exchange rate will be determined by expected inflation and the output gap or the unemployment gap of the home and foreign countries this paper examines the implications of these taylor rule fundamentals for real exchange rate determination because the true parameters in central bank policy rules are unknown to the public and change over time the model is presented in the context of a least squares learning environment this simple learning model captures the volatility and the major swings in the real deutschemark euro dollar exchange rate from 1976 to 2007

complexity and economic policy a paradigm shift or a change in perspective a review essay on david colander and roland kupers s complexity and the art of public policy in their recent book colander and kupers 2014 argue that viewing the economy as a complex adaptive system should change the way in which we make economic policy this would necessitate a paradigm shift economics has over time tried to produce a coherent model to underpin the dominant laissez faire liberal approach but we have never proved in that model that left to their own devices the participants in an economy will self organize into a satisfactory state this is an assumption complex interactive systems with direct interaction between heterogeneous agents may show no tendency to self equilibrate and will undergo endogenous crises economists should concentrate on the emergence of certain patterns colander and kupers suggest that we may be able to nudge the system into good basins of attraction a more radical view is that there are no fixed basins of attraction these change with the evolution of the system and it is illusory to believe that we can choose good basins we may be able to recognize and influence the emergence of certain states of the economy but we are far from leon walras s dream of economics as a science like astrophysics

economic momentum and currency returns abstract past trends in fundamentals linked to economic activity and inflation predict currency returns we find that a trading strategy that goes long currencies with strong economic momentum and short currencies with weak economic momentum exhibits an annualized sharpe ratio of 0 70 and yields a significant alpha when controlling for standard carry momentum and value strategies the economic momentum strategy subsumes the alpha of carry trades suggesting that differences in past economic trends capture cross country differences in carry

symbiosis of monetary and fiscal policies in a monetary union we consider the interaction between the monetary policy in a monetary union and the separate fiscal policies of the member countries we use a barro gordon type model extended to many countries and fiscal policies each country s fiscal policies inflict externalities on other countries and the common monetary policy has its time consistency problem but if the two types of policymakers agree about the ideal levels of output and inflation then this ideal is attained despite disagreements about the weights of the objectives despite ex post monetary accommodation to fiscal profligacy without fiscal coordination without monetary commitment and for any order of moves

fiscal and monetary rules for a currency union abstract this paper addresses the optimal joint conduct of fiscal and monetary policy in a two country model of a currency union with staggered price setting and distortionary taxes a tractable linear quadratic approximation permits a representation of the optimal policy plan in terms of targeting rules in the optimal equilibrium monetary policy should achieve aggregate price stability following a flexible inflation targeting rule fiscal policy should stabilize idiosyncratic shocks allowing for permanent variations of government debt but should abstain from creating inflationary expectations at the union level simple policy rules can approximate the optimal commitment benchmark through a mix of strict inflation targeting and flexible budget rules conversely the welfare costs of balanced budget rules are at least one order of magnitude higher than conventional estimates of the costs of business cycle fluctuactions

welfare and macroeconomic interdependence we develop a baseline model of monetary and fiscal transmission in interdependent economies the welfare effects of expansionary policies are related to monopolistic supply in production and monopoly power of a country in trade an unanticipated exchange rate depreciation can be beggar thyself rather than beggar thy neighbor as gains in domestic output are offset by deteriorating terms of trade smaller and more open economies are more prone to suffer from inflationary shocks larger economies benefit from moderate demand led expansions but may be worse off if policy makers attempt to close the output gap fiscal shocks are generally beggar thy neighbor in the long run in the short run they raise domestic demand at given terms of trade thus reducing the welfare benefits from monetary expansions analytical tractability makes our model uniquely suitable as a starting point to approach the recent new open economy macroeconomic literature

interactions of commitment and discretion in monetary and fiscal policies we consider monetary scal interactions when the monetary authority is more conservative than the scal with both policies discretionary 1 nash equilibrium yields lower output and higher price than the ideal points of both authorities 2 of the two leadership possibilities scal leadership is generally better with scal discretion monetary commitment yields the same outcome as discretionary monetary leadership for all realizations of shocks but scal commitment is not similarly negated by monetary discretion second best outcomes require either joint commitment or identical targets for both authorities output socially optimal and price level appropriately conservative or complete separation of tasks jel e61 e63

taylor rules and the deutschmark dollar real exchange rate we explore the link between an interest rate rule for monetary policy and the behavior of the real exchange rate the interest rate rule in conjunction with some standard assumptions implies that the deviation of the real exchange rate from its steady state depends on the present value of a weighted sum of inflation and output gap differentials the weights are functions of the parameters of the interest rate rule an initial look at german data yields some support for the model

exchange rate predictability the main goal of this article is to provide an answer to the question does anything forecast exchange rates and if so which variables it is well known that exchange rate fluctuations are very difficult to predict using economic models and that a random walk forecasts exchange rates better than any economic model the meese and rogoff puzzle however the recent literature has identified a series of fundamentals methodologies that claim to have resolved the puzzle this article provides a critical review of the recent literature on exchange rate forecasting and illustrates the new methodologies and fundamentals that have been recently proposed in an up to date thorough empirical analysis overall our analysis of the literature and the data suggests that the answer to the question are exchange rates predictable is it depends on the choice of predictor forecast horizon sample period model and forecast evaluation method predictability is most apparent when one or more of the following hold the predictors are taylor rule or net foreign assets the model is linear and a small number of parameters are estimated the toughest benchmark is the random walk without drift

taylor rules with real time data a tale of two countries and one exchange rate abstract using real time data that reflects information available to monetary authorities at the time they are formulating policy we find that estimated taylor rules based on revised and real time data differ more for germany than for the u s taylor rules using real time data suggest differences between u s and german monetary policies and taylor rules for the u s using inflation forecasts are nearly identical to those using lagged inflation rates evidence of out of sample predictability for the dollar mark nominal exchange rate with forecasts based on taylor rule fundamentals is only found with real time data and does not increase if inflation forecasts are used

learning to forecast the exchange rate two competing approaches this paper compares two competing approaches to model foreign exchange market participants behavior statistical learning and fitness learning these learning mechanisms are applied to a set of predictors chartist and fundamentalist rules we examine which of the learning approaches is best in terms of replicating the exchange rate dynamics within the framework of a standard asset pricing model we find that both learning methods reveal the fundamental value of the exchange rate in the equilibrium but only fitness learning creates the disconnection phenomenon and only statistical learning replicates volatility clustering none of the mechanisms is able to produce a unit root process but both of them generate non normally distributed returns

forecasting exchange rates out of sample with panel methods and real time data abstract this paper evaluates out of sample exchange rate forecasting with purchasing power parity ppp and taylor rule fundamentals for 9 oecd countries vis a vis the u s dollar over the period from 1973 q1 to 2009 q1 at short and long horizons in contrast with previous work which reports forecasts using revised data i construct a quarterly real time dataset that incorporates only the information available to market participants when the forecasts were made using bootstrapped out of sample test statistics the exchange rate model with taylor rule fundamentals performs better at the one quarter horizon and panel estimation is not able to improve its performance the ppp model however forecasts better at the 16 quarter horizon and its performance increases in panel framework the results are in accord with previous research on ppp and taylor rule models

on the relevance of exchange rate regimes for stabilization policy this paper assesses the relevance of the exchange rate regime for stabilization policy using both fiscal and monetary policy we conclude that the exchange rate regime is irrelevant this is the case independently of the severity of price rigidities independently of asymmetries across countries in shocks and transmission mechanisms the only relevant conditions are on the mobility of labor and financial assets the results can be summarized with the claim that every currency area is an optimal currency area however with labor mobility or tradable state contingent assets additional policy instruments would be required to establish the irrelevance result

micro shocks and aggregate risk the paper presents a micro shock explanation of aggregate risk shocks are independent over agents and equilibria are always unique it is shown that any amount of aggregate risk can be generated by games in which shocks to players are independent explicit examples are given some of which elaborate on examples in the literature implications are drawn for factor analytic methods of extracting aggregate shocks

taylor rule deviations and out of sample exchange rate predictability abstract the taylor rule has become the dominant model for academic evaluation of out of sample exchange rate predictability two versions of the taylor rule model are the taylor rule fundamentals model where the variables that enter the taylor rule are used to forecast exchange rate changes and the taylor rule differentials model where a taylor rule with postulated coefficients is used in the forecasting regression we use data from 1973 to 2014 to evaluate short run out of sample predictability for eight exchange rates vis a vis the u s dollar and find strong evidence in favor of the taylor rule fundamentals model alternative against the random walk null the evidence of predictability is weaker with the taylor rule differentials model and still weaker with the traditional interest rate differential purchasing power parity and monetary models the evidence of predictability for the fundamentals model is not related to deviations from the original taylor rule for the u s but is related to deviations from a modified taylor rule for the u s with a higher coefficient on the output gap the evidence of predictability is also unrelated to deviations from taylor rules for the foreign countries and adherence to the taylor principle for the u s

goods prices and exchange rates what have we learned import prices typically change by a smaller proportion than the exchange rate between the exporting and importing country recent research indicates that common currency relative prices for similar goods exported to different markets are highly correlated with exchange rates between those markets this evidence suggests that incomplete pass through is a consequence of third degree price discrimination while distance matters for market segmentation borders have independent effects the source of the border effect has not been clearly identified furthermore there is little evidence yet to suggest substantial market power is implied by the observed price discrimination

incomplete pass through and the welfare effects of exchange rate variability abstract this paper considers the implications of incomplete exchange rate pass through for optimal monetary and exchange rate policy a two country model is presented which allows an explicit derivation of welfare functions in terms of a weighted sum of the second moments of producer prices and the nominal exchange rate from a single country perspective the optimal exchange rate variance depends on the degree of pass through the size and openness of the economy the elasticity of labour supply and the volatility of foreign producer prices welfare may be decreasing or increasing in the volatility of the exchange rate

international dimensions of optimal monetary policy abstract this paper provides a baseline general equilibrium model of optimal monetary policy among interdependent economies with monopolistic firms and nominal rigidities an inward looking policy of domestic price stabilization is not optimal when firms markups are exposed to currency fluctuations such a policy raises exchange rate volatility leading foreign exporters to charge higher prices vis a vis increased uncertainty in the export market as higher import prices reduce the purchasing power of domestic consumers optimal monetary rules trade off a larger domestic output gap against lower consumer prices optimal rules in a world nash equilibrium lead to less exchange rate volatility relative to both inward looking rules and discretionary policies even when the latter do not suffer from any inflationary or deflationary bias gains from international monetary cooperation are related in a non monotonic way to the degree of exchange rate pass through

taylor rules and the canadian us equilibrium exchange rate abstract this paper identifies the canadian us equilibrium exchange rate based on a simple structural model of the real exchange rate in which monetary policy follows a taylor rule interest rate reaction function the exchange rate is explained by relative output and inflation as observable variables and by unobserved equilibrium rates as well as unobserved transitory components in output and the exchange rate using canadian data over 1974 2009 we jointly estimate the unobserved components and the structural parameters using the kalman filter and bayesian technique we find that canada s equilibrium exchange rate evolves smoothly and follows a trend depreciation the transitory component is found to be very persistent but much more volatile than the equilibrium rate resulting in few but prolonged periods of currency misalignments

the uncovered interest parity puzzle exchange rate forecasting and taylor rules abstract recent research has found that the taylor rule fundamentals have power to forecast changes in u s dollar exchange rates out of sample our work casts some doubt on that claim however we find strong evidence of a related in sample anomaly when we include u s inflation in the well known uncovered interest parity regression of the change in the exchange rate on the interest rate differential we find that the inflation variable is highly significant and the interest rate differential is not specifically high u s inflation in one month forecasts dollar appreciation in the subsequent month we introduce a model in which a taylor rule determines monetary policy but in which not only monetary shocks but also liquidity shocks drive nominal interest rates this model can potentially account for the empirical findings

the taylor rule and forecast intervals for exchange rates in this paper we examine the meese rogoff puzzle from a different perspective out of sample interval forecasting while most studies in the literature focus on point forecasts we apply semiparametric interval forecasting to a group of exchange rate models forecast intervals for 10 oecd exchange rates are generated and the performance of the empirical exchange rate models are compared with the random walk our contribution is twofold first we find that in general exchange rate models generate tighter forecast intervals than the random walk given that their intervals cover out of sample exchange rate realizations equally well our results suggest a connection between exchange rates and economic fundamentals economic variables contain information useful in forecasting distributions of exchange rates we also find that the benchmark taylor rule model performs better than the monetary ppp and forward premium models and its advantages are more pronounced at longer horizons second the bootstrap inference framework proposed in this paper for forecast interval evaluation can be applied in a broader context such as inflation forecasting

the panel purchasing power parity puzzle does long run purchasing power parity ppp hold over the post 1973 floating exchange rate period panel unit root tests provide evidence of ppp that increases with the number of observations the strengthening of the evidence however is highly cyclical when the dollar appreciates at the end of the sample the evidence of ppp strengthens and when it depreciates the evidence weakens while these patterns cannot be explained by the specifications that are normally used to model real exchange rates the strengthening but not the cyclical pattern can be explained by a specifi cation that incorporates ppp restricted structural change

taylor rules and exchange rate predictability in emerging economies abstract this study demonstrates the relationship between exchange rate determination and an endogenous monetary policy represented by taylor rules we fill a gap in the literature by focusing on a group of fifteen emerging economies that adopted free floating exchange rates and inflation targeting beginning in the mid 1990s because of the limited span of the time series which is a common obstacle to studying emerging economies we employ panel data regressions to produce more efficient estimates following the recent literature we use a robust set of out of sample statistics incorporating bootstrapped and asymptotic distributions for the diebold mariano statistic the clark and west statistic and theil s u ratio by evaluating different specifications for the taylor rule exchange rate model based on their out of sample performances we find that a present value forward looking specification shows strong evidence of exchange rate predictability

exchange rates and individual good s price misalignment evidence of long horizon predictability although purchasing power parity fundamentals in general have only weak predictability currency misalignment may be indicated by price differentials for some individual goods which could then have predictive power for subsequent re evaluation of the nominal exchange rate we collect good level price data to construct deviations from the law of one price and examine the resulting price misalignment model s predictive power for the nominal exchange rates between the u s dollar and two other currencies the japanese yen and the u k pound we find that the slope coefficients and r squares of in sample forecasting regressions for almost all goods in our data increase with the forecast horizon for the bilateral exchange rates between the u s dollar and the japanese yen and the u s dollar and the u k pound the results of tests for out of sample superior predictive ability suggest that our price misalignment model outperforms a random walk model either with or without drift for the u s dollar vis a vis the japanese yen at the 5 percent level of significance over long horizons

a realistic model for official interest rate movements and their consequences this article extends the vector autoregression var methodology to examine the consequences of monetary policy decisions by considering two types of nonlinearities in the determination of official interest rates 1 the asymmetry related to the different nature of the discrete and infrequent positive and negative interest rate movements determined by central bankers and 2 the convexity in the transmission of policy shocks induced by the nonnegativity constraint in interest rates for the uk we find some evidence of both types of asymmetries in the us responses to unexpected interest rate shocks are far more symmetric results highlight the importance of considering all types of asymmetries when studying monetary transmission

frequency of price adjustment and pass through we empirically document using u s import prices that on average goods with a high frequency of price adjustment have a long run pass through that is at least twice as high as that of low frequency adjusters we show theoretically that this relationship should follow because variable mark ups that reduce long run pass through also reduces the curvature of the proflt function when expressed as a function of the cost shocks making the flrm less willing to adjust its price lastly we quantitatively evaluate a dynamic menu cost model and show that the variable mark up channel can generate signiflcant variation in frequency equivalent to 37 of the observed variation in the data on the other hand the standard workhorse model with constant elasticity of demand and calvo or state dependent pricing has di culty matching the facts

model uncertainty in panel vector autoregressive models we develop methods for bayesian model averaging bma or selection bms in panel vector autoregressions pvars our approach allows us to select between or average over all possible combinations of restricted pvars where the restrictions involve interdependencies between and heterogeneities across cross sectional units the resulting bma framework can find a parsimonious pvar specification thus dealing with overparameterization concerns we use these methods in an application involving the euro area sovereign debt crisis and show that our methods perform better than alternatives our findings contradict a simple view of the sovereign debt crisis which divides the euro zone into groups of core and peripheral countries and worries about financial contagion within the latter group

out of sample exchange rate predictability with taylor rule fundamentals abstract an extensive literature that studied the performance of empirical exchange rate models following meese and rogoff s meese r a rogoff k 1983a empirical exchange rate models of the seventies do they fit out of sample journal of international economics 14 3 24 seminal paper has not convincingly found evidence of out of sample exchange rate predictability this paper extends the conventional set of models of exchange rate determination by investigating predictability of models that incorporate taylor rule fundamentals we find evidence of short term predictability for 11 out of 12 currencies vis a vis the u s dollar over the post bretton woods float with the strongest evidence coming from specifications that incorporate heterogeneous coefficients and interest rate smoothing the evidence of predictability is much stronger with taylor rule models than with conventional interest rate purchasing power parity or monetary models

testing the relative purchasing power parity hypothesis the case of korea abstractthis study examines the relative purchasing power parity ppp hypothesis using the data from the korean won us dollar and the korean won japanese yen foreign exchange markets we extract proxies for inflation from stock market returns of korea the united states and japan based on the method used by chowdhry roll and xia in 2005 we explicitly test the relative ppp hypothesis in light of the short run price volatility using monthly bimonthly and quarterly data from 1 january 1998 to 31 december 2012 our findings suggest that the empirical test results from the entire sample period do not support the relative ppp hypothesis however the results from the sample period excluding the asian financial crisis period show that the relative ppp hypothesis holds for the korean won us dollar market with a moderate magnitude of inflation impact but not for the korean won japanese yen market abrupt changes in exchange rates during the crisis period may have affected the relationship between inflation an