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Taylor Rules and the Euro


  • The authors would like to thank Yu-Chin Chen, Luisa Corrado, Lutz Kilian, Sylvain Leduc, Michael McCracken, Barbara Rossi, Ken West, two anonymous referees, and participants at the EABCN Conference, Using Euro Area Data: Issues and Consequences for Economic Analysis; the 2008 CIRANO Workshop on Macroeconomic Forecasting, Analysis, and Policy with Data Revision; the 2008 SCCIE International Economics Conference; the Applied Econometrics and Forecasting in Macroeconomics and Finance Workshop at Federal Reserve Bank of St. Louis; Texas Camp Econometrics 2009; the 2009 North American Summer Meeting of the Econometric Society; the 2009 NBER Summer Institute International Finance and Macroeconomics Meeting; Ohio State University; the European Central Bank; and the Federal Reserve Bank of Atlanta for helpful comments and discussions.


This article uses real-time data to show that inflation and either the output gap or unemployment, variables which normally enter central banks’ Taylor rules, can provide evidence of out-of-sample predictability for the U.S. dollar/euro exchange rate from 1999 to 2007. The strongest evidence is found for specifications that constrain the coefficients on inflation and real economic activity to be the same for the United States and the Euro Area, do not incorporate interest rate smoothing, and do not include the real exchange rate in the forecasting regression. Evidence of predictability is found with both one-quarter-ahead and longer-horizon forecasts.