Forecasting the exchange rate with the Taylor rule model during times of alternative monetary policies

Abstract

AbstractThis study aims to incorporate the effects of recently used alternative monetary policies, such as quantitative easing into standard Taylor rule exchange rate models. Using out‐of‐sample forecasting, we determine whether including long‐term government bond yields and shadow interest rates improves on these model's performance. Using data from the Eurozone, Japan, United Kingdom, and United States, we perform out‐of‐sample forecasts using a rolling window; the results suggest that the model with government bond returns performs best against the random walk, although the results vary across countries, particularly when we compare the forecasts with those produced by a version of uncovered interest parity (UIP).