Discussion: Molodtsova and Papell, `Phoenix Taylor Rule ...
Transcript of Discussion: Molodtsova and Papell, `Phoenix Taylor Rule ...
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Summary Comments
Discussion: Molodtsova and Papell, ‘PhoenixTaylor Rule Exchange Rate Forecasting
During the Financial Crisis’
Jan J. J. Groen
Federal Reserve Bank of New York
January 7, 2011AEA Meetings, Denver
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Summary Comments
First...
The views expressed in this presentation are mine and do notnecessarily reflect those of the Federal Reserve Bank of New
York or the Federal Reserve System.
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Summary Comments
Outline
Summary
Comments
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Summary Comments
Literature
• Since Meese and Rogoff (1983, JIE)→ No predictivepower macroeconomic series for short-term exchange ratechanges.
• Maybe more successful at multi-year horizons? Mark(1995, AER)
• In particular within multi-country panels: Mark and Sul(2001, JIE), Groen (2005, JMCB).
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Summary Comments
Literature
• Since Meese and Rogoff (1983, JIE)→ No predictivepower macroeconomic series for short-term exchange ratechanges.
• Maybe more successful at multi-year horizons? Mark(1995, AER)
• In particular within multi-country panels: Mark and Sul(2001, JIE), Groen (2005, JMCB).
![Page 6: Discussion: Molodtsova and Papell, `Phoenix Taylor Rule ...](https://reader031.fdocuments.us/reader031/viewer/2022031517/622b6f6bd194316c194b032f/html5/thumbnails/6.jpg)
Summary Comments
ResultsPapers follows Molodtsova and Papell (2009, JIE)→ Taylor rulefundamentals HAVE short-run forecasting power for exchangerate changes.
ADDITION: Use real-time data when constructing forecasts(NOT when estimating!).Results for forecasting sample 2007-2009:• Recursive statistical evaluation of forecast power vs.
random walk: Up to the Lehman’s crisis Taylorfundamentals better than monetary fundamentals, PPP,relative interest rates.
However: Everything breaks down during the 2008-2009Lehman’s episode and evidence pro Taylor fundamentalsmuch weaker using forecasted variables.
• From late-2009 Taylor fundamentals perform better again.
![Page 7: Discussion: Molodtsova and Papell, `Phoenix Taylor Rule ...](https://reader031.fdocuments.us/reader031/viewer/2022031517/622b6f6bd194316c194b032f/html5/thumbnails/7.jpg)
Summary Comments
ResultsPapers follows Molodtsova and Papell (2009, JIE)→ Taylor rulefundamentals HAVE short-run forecasting power for exchangerate changes.
ADDITION: Use real-time data when constructing forecasts(NOT when estimating!).Results for forecasting sample 2007-2009:• Recursive statistical evaluation of forecast power vs.
random walk: Up to the Lehman’s crisis Taylorfundamentals better than monetary fundamentals, PPP,relative interest rates.
However: Everything breaks down during the 2008-2009Lehman’s episode and evidence pro Taylor fundamentalsmuch weaker using forecasted variables.
• From late-2009 Taylor fundamentals perform better again.
![Page 8: Discussion: Molodtsova and Papell, `Phoenix Taylor Rule ...](https://reader031.fdocuments.us/reader031/viewer/2022031517/622b6f6bd194316c194b032f/html5/thumbnails/8.jpg)
Summary Comments
ResultsPapers follows Molodtsova and Papell (2009, JIE)→ Taylor rulefundamentals HAVE short-run forecasting power for exchangerate changes.
ADDITION: Use real-time data when constructing forecasts(NOT when estimating!).Results for forecasting sample 2007-2009:• Recursive statistical evaluation of forecast power vs.
random walk: Up to the Lehman’s crisis Taylorfundamentals better than monetary fundamentals, PPP,relative interest rates.
However: Everything breaks down during the 2008-2009Lehman’s episode and evidence pro Taylor fundamentalsmuch weaker using forecasted variables.
• From late-2009 Taylor fundamentals perform better again.
![Page 9: Discussion: Molodtsova and Papell, `Phoenix Taylor Rule ...](https://reader031.fdocuments.us/reader031/viewer/2022031517/622b6f6bd194316c194b032f/html5/thumbnails/9.jpg)
Summary Comments
ResultsPapers follows Molodtsova and Papell (2009, JIE)→ Taylor rulefundamentals HAVE short-run forecasting power for exchangerate changes.
ADDITION: Use real-time data when constructing forecasts(NOT when estimating!).Results for forecasting sample 2007-2009:• Recursive statistical evaluation of forecast power vs.
random walk: Up to the Lehman’s crisis Taylorfundamentals better than monetary fundamentals, PPP,relative interest rates.
However: Everything breaks down during the 2008-2009Lehman’s episode and evidence pro Taylor fundamentalsmuch weaker using forecasted variables.
• From late-2009 Taylor fundamentals perform better again.
![Page 10: Discussion: Molodtsova and Papell, `Phoenix Taylor Rule ...](https://reader031.fdocuments.us/reader031/viewer/2022031517/622b6f6bd194316c194b032f/html5/thumbnails/10.jpg)
Summary Comments
Outline
Summary
Comments
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Summary Comments
Some Data Issues
• Identical Monetary Policy pre- and post-1999 for euroarea?
• pre-1999: (Implicitly) Bundesbank.• post-1999: Continuation of Bundesbank?
Not necessarily→ see Hayo and Hofmann (2006, EmpiricalEconomics). Potentially problematic, e.g., splicing Germanwith (synthetic) euro area data.
• Why not also use other economies than euro area withricher real-time data sets?
• U.K.: Has GDP vintages going back further than 1999→Groen, Kapetanios and Price (2009, IJF).
• Interesting: (i) ‘real’ real-time comparison, and (ii) bothU.S. and U.K. went to the zero-bound aggressively afterLehman’s.
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Summary Comments
Some Data Issues
• Identical Monetary Policy pre- and post-1999 for euroarea?
• pre-1999: (Implicitly) Bundesbank.• post-1999: Continuation of Bundesbank?
Not necessarily→ see Hayo and Hofmann (2006, EmpiricalEconomics). Potentially problematic, e.g., splicing Germanwith (synthetic) euro area data.
• Why not also use other economies than euro area withricher real-time data sets?
• U.K.: Has GDP vintages going back further than 1999→Groen, Kapetanios and Price (2009, IJF).
• Interesting: (i) ‘real’ real-time comparison, and (ii) bothU.S. and U.K. went to the zero-bound aggressively afterLehman’s.
![Page 13: Discussion: Molodtsova and Papell, `Phoenix Taylor Rule ...](https://reader031.fdocuments.us/reader031/viewer/2022031517/622b6f6bd194316c194b032f/html5/thumbnails/13.jpg)
Summary Comments
Some Data Issues
• Identical Monetary Policy pre- and post-1999 for euroarea?
• pre-1999: (Implicitly) Bundesbank.• post-1999: Continuation of Bundesbank?
Not necessarily→ see Hayo and Hofmann (2006, EmpiricalEconomics). Potentially problematic, e.g., splicing Germanwith (synthetic) euro area data.
• Why not also use other economies than euro area withricher real-time data sets?
• U.K.: Has GDP vintages going back further than 1999→Groen, Kapetanios and Price (2009, IJF).
• Interesting: (i) ‘real’ real-time comparison, and (ii) bothU.S. and U.K. went to the zero-bound aggressively afterLehman’s.
![Page 14: Discussion: Molodtsova and Papell, `Phoenix Taylor Rule ...](https://reader031.fdocuments.us/reader031/viewer/2022031517/622b6f6bd194316c194b032f/html5/thumbnails/14.jpg)
Summary Comments
Some Data Issues
• Identical Monetary Policy pre- and post-1999 for euroarea?
• pre-1999: (Implicitly) Bundesbank.• post-1999: Continuation of Bundesbank?
Not necessarily→ see Hayo and Hofmann (2006, EmpiricalEconomics). Potentially problematic, e.g., splicing Germanwith (synthetic) euro area data.
• Why not also use other economies than euro area withricher real-time data sets?
• U.K.: Has GDP vintages going back further than 1999→Groen, Kapetanios and Price (2009, IJF).
• Interesting: (i) ‘real’ real-time comparison, and (ii) bothU.S. and U.K. went to the zero-bound aggressively afterLehman’s.
![Page 15: Discussion: Molodtsova and Papell, `Phoenix Taylor Rule ...](https://reader031.fdocuments.us/reader031/viewer/2022031517/622b6f6bd194316c194b032f/html5/thumbnails/15.jpg)
Summary Comments
Some Data Issues
• Identical Monetary Policy pre- and post-1999 for euroarea?
• pre-1999: (Implicitly) Bundesbank.• post-1999: Continuation of Bundesbank?
Not necessarily→ see Hayo and Hofmann (2006, EmpiricalEconomics). Potentially problematic, e.g., splicing Germanwith (synthetic) euro area data.
• Why not also use other economies than euro area withricher real-time data sets?
• U.K.: Has GDP vintages going back further than 1999→Groen, Kapetanios and Price (2009, IJF).
• Interesting: (i) ‘real’ real-time comparison, and (ii) bothU.S. and U.K. went to the zero-bound aggressively afterLehman’s.
![Page 16: Discussion: Molodtsova and Papell, `Phoenix Taylor Rule ...](https://reader031.fdocuments.us/reader031/viewer/2022031517/622b6f6bd194316c194b032f/html5/thumbnails/16.jpg)
Summary Comments
Taylor Rule Fundamentals I
• Taylor rule: it = µ+ (1 + φ)πt + γyt + εt
Taylor rule more than interest rate function of inflation andoutput gap/slack. Implies certain parameters restrictions→Taylor Principle.
• Taylor Principle: (1 + φ) > 1 and γ > 0
Violation: No correction back to inflation target→ andomestic interest rate hike has no/depreciating effect ondomestic currency.
• Authors silent about this; no direct estimates of (1 + φ) andγ. But what they show is a bit disconcerting:
![Page 17: Discussion: Molodtsova and Papell, `Phoenix Taylor Rule ...](https://reader031.fdocuments.us/reader031/viewer/2022031517/622b6f6bd194316c194b032f/html5/thumbnails/17.jpg)
Summary Comments
Taylor Rule Fundamentals I
• Taylor rule: it = µ+ (1 + φ)πt + γyt + εt
Taylor rule more than interest rate function of inflation andoutput gap/slack. Implies certain parameters restrictions→Taylor Principle.
• Taylor Principle: (1 + φ) > 1 and γ > 0
Violation: No correction back to inflation target→ andomestic interest rate hike has no/depreciating effect ondomestic currency.
• Authors silent about this; no direct estimates of (1 + φ) andγ. But what they show is a bit disconcerting:
![Page 18: Discussion: Molodtsova and Papell, `Phoenix Taylor Rule ...](https://reader031.fdocuments.us/reader031/viewer/2022031517/622b6f6bd194316c194b032f/html5/thumbnails/18.jpg)
Summary Comments
Taylor Rule Fundamentals I
• Taylor rule: it = µ+ (1 + φ)πt + γyt + εt
Taylor rule more than interest rate function of inflation andoutput gap/slack. Implies certain parameters restrictions→Taylor Principle.
• Taylor Principle: (1 + φ) > 1 and γ > 0
Violation: No correction back to inflation target→ andomestic interest rate hike has no/depreciating effect ondomestic currency.
• Authors silent about this; no direct estimates of (1 + φ) andγ. But what they show is a bit disconcerting:
![Page 19: Discussion: Molodtsova and Papell, `Phoenix Taylor Rule ...](https://reader031.fdocuments.us/reader031/viewer/2022031517/622b6f6bd194316c194b032f/html5/thumbnails/19.jpg)
Summary Comments
Taylor Rule Fundamentals I
• Taylor rule: it = µ+ (1 + φ)πt + γyt + εt
Taylor rule more than interest rate function of inflation andoutput gap/slack. Implies certain parameters restrictions→Taylor Principle.
• Taylor Principle: (1 + φ) > 1 and γ > 0
Violation: No correction back to inflation target→ andomestic interest rate hike has no/depreciating effect ondomestic currency.
• Authors silent about this; no direct estimates of (1 + φ) andγ. But what they show is a bit disconcerting:
![Page 20: Discussion: Molodtsova and Papell, `Phoenix Taylor Rule ...](https://reader031.fdocuments.us/reader031/viewer/2022031517/622b6f6bd194316c194b032f/html5/thumbnails/20.jpg)
Summary Comments
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Summary Comments
Taylor Rule Fundamentals I
• Taylor rule: it = µ+ (1 + φ)πt + γyt + εt
Taylor rule more than interest rate function of inflation andoutput gap/slack. Implies certain parameters restrictions→Taylor Principle.
• Taylor Principle: (1 + φ) > 1 and γ > 0
Violation: No correction back to inflation target→ andomestic interest rate hike has no/depreciating effect ondomestic currency.
• Authors silent about this; no direct estimates of (1 + φ) andγ. But what they show is a bit disconcerting: Policy rulechanges more slow moving; see, e.g., Kim and Nelson(2006, JME)
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Summary Comments
Taylor Rule Fundamentals II• Ad hoc mapping Taylor rule fundamentals to exchange
rate! What does it means?• Gives a very loose, hard to interpret relationship between
exchange rates and Taylor fundamentals.
Similar one based on monetary fundamentals→ maybenot bad forecasting performance!
• Alternative: difficult, but maybe through relative pricingkernels (see Ang and Piazzesi (2003)):
∆sit+1 = ln
(M∗
t+1
Mt+1
)= rt−r∗t +
12
(λ2
t − (λ∗t )2)
+λtεt+1−λitε
it+1
• Maybe symptom that macroeconomic drivers themselvesare unobserved (Engel and West 2005)→ Utilize dynamicfactors (Groen (2010), Adrian, Etula and Groen (2010))?
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Summary Comments
Taylor Rule Fundamentals II• Ad hoc mapping Taylor rule fundamentals to exchange
rate! What does it means?• Gives a very loose, hard to interpret relationship between
exchange rates and Taylor fundamentals.
Similar one based on monetary fundamentals→ maybenot bad forecasting performance!
• Alternative: difficult, but maybe through relative pricingkernels (see Ang and Piazzesi (2003)):
∆sit+1 = ln
(M∗
t+1
Mt+1
)= rt−r∗t +
12
(λ2
t − (λ∗t )2)
+λtεt+1−λitε
it+1
• Maybe symptom that macroeconomic drivers themselvesare unobserved (Engel and West 2005)→ Utilize dynamicfactors (Groen (2010), Adrian, Etula and Groen (2010))?
![Page 24: Discussion: Molodtsova and Papell, `Phoenix Taylor Rule ...](https://reader031.fdocuments.us/reader031/viewer/2022031517/622b6f6bd194316c194b032f/html5/thumbnails/24.jpg)
Summary Comments
Taylor Rule Fundamentals II• Ad hoc mapping Taylor rule fundamentals to exchange
rate! What does it means?• Gives a very loose, hard to interpret relationship between
exchange rates and Taylor fundamentals.
Similar one based on monetary fundamentals→ maybenot bad forecasting performance!
• Alternative: difficult, but maybe through relative pricingkernels (see Ang and Piazzesi (2003)):
∆sit+1 = ln
(M∗
t+1
Mt+1
)= rt−r∗t +
12
(λ2
t − (λ∗t )2)
+λtεt+1−λitε
it+1
• Maybe symptom that macroeconomic drivers themselvesare unobserved (Engel and West 2005)→ Utilize dynamicfactors (Groen (2010), Adrian, Etula and Groen (2010))?
![Page 25: Discussion: Molodtsova and Papell, `Phoenix Taylor Rule ...](https://reader031.fdocuments.us/reader031/viewer/2022031517/622b6f6bd194316c194b032f/html5/thumbnails/25.jpg)
Summary Comments
Taylor Rule Fundamentals II• Ad hoc mapping Taylor rule fundamentals to exchange
rate! What does it means?• Gives a very loose, hard to interpret relationship between
exchange rates and Taylor fundamentals.
Similar one based on monetary fundamentals→ maybenot bad forecasting performance!
• Alternative: difficult, but maybe through relative pricingkernels (see Ang and Piazzesi (2003)):
∆sit+1 = ln
(M∗
t+1
Mt+1
)= rt−r∗t +
12
(λ2
t − (λ∗t )2)
+λtεt+1−λitε
it+1
• Maybe symptom that macroeconomic drivers themselvesare unobserved (Engel and West 2005)→ Utilize dynamicfactors (Groen (2010), Adrian, Etula and Groen (2010))?
![Page 26: Discussion: Molodtsova and Papell, `Phoenix Taylor Rule ...](https://reader031.fdocuments.us/reader031/viewer/2022031517/622b6f6bd194316c194b032f/html5/thumbnails/26.jpg)
Summary Comments
Taylor Rule Fundamentals II• Ad hoc mapping Taylor rule fundamentals to exchange
rate! What does it means?• Gives a very loose, hard to interpret relationship between
exchange rates and Taylor fundamentals.
Similar one based on monetary fundamentals→ maybenot bad forecasting performance!
• Alternative: difficult, but maybe through relative pricingkernels (see Ang and Piazzesi (2003)):
∆sit+1 = ln
(M∗
t+1
Mt+1
)= rt−r∗t +
12
(λ2
t − (λ∗t )2)
+λtεt+1−λitε
it+1
• Maybe symptom that macroeconomic drivers themselvesare unobserved (Engel and West 2005)→ Utilize dynamicfactors (Groen (2010), Adrian, Etula and Groen (2010))?
![Page 27: Discussion: Molodtsova and Papell, `Phoenix Taylor Rule ...](https://reader031.fdocuments.us/reader031/viewer/2022031517/622b6f6bd194316c194b032f/html5/thumbnails/27.jpg)
Summary Comments
What Drove the 2008-2009 Forecast Breakdown?
• Likely due to exceptional developments not picked up bythe models under consideration.
• Maybe exceptional risk premium behavior amplified bychanges in financial institutions’ funding conditions→Adrian, Etula and Groen (2010).
• Adrian, Etula and Groen (2010): Use dynamic factors tomodel UIP deviations→
global real activity, global inflation, and U.S. financialinstitutions’ balance sheet conditions.
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Summary Comments
What Drove the 2008-2009 Forecast Breakdown?
• Likely due to exceptional developments not picked up bythe models under consideration.
• Maybe exceptional risk premium behavior amplified bychanges in financial institutions’ funding conditions→Adrian, Etula and Groen (2010).
• Adrian, Etula and Groen (2010): Use dynamic factors tomodel UIP deviations→
global real activity, global inflation, and U.S. financialinstitutions’ balance sheet conditions.
![Page 29: Discussion: Molodtsova and Papell, `Phoenix Taylor Rule ...](https://reader031.fdocuments.us/reader031/viewer/2022031517/622b6f6bd194316c194b032f/html5/thumbnails/29.jpg)
Summary Comments
What Drove the 2008-2009 Forecast Breakdown?
• Likely due to exceptional developments not picked up bythe models under consideration.
• Maybe exceptional risk premium behavior amplified bychanges in financial institutions’ funding conditions→Adrian, Etula and Groen (2010).
• Adrian, Etula and Groen (2010): Use dynamic factors tomodel UIP deviations→
global real activity, global inflation, and U.S. financialinstitutions’ balance sheet conditions.
![Page 30: Discussion: Molodtsova and Papell, `Phoenix Taylor Rule ...](https://reader031.fdocuments.us/reader031/viewer/2022031517/622b6f6bd194316c194b032f/html5/thumbnails/30.jpg)
Summary Comments
.02
0.0
2.0
4
1990m1 1995m1 2000m1 2005m1 2010m1
Macro and Balance Sheet Risk PremiumMacro Risk Premium
42
02
1990m1 1995m1 2000m1 2005m1 2010m1
Balance Sheet VariableBalance Sheet Variable predicted by Nonlinear Macro Variables