Recent
Published Papers

Taylor Rule
Exchange Rate Forecasting During the Financial Crisis

(with Tanya
Molodtsova)

This paper
evaluates out-of-sample exchange rate predictability of Taylor rule models,
where the central bank sets the interest rate in response to inflation and
either the output or the unemployment gap, for the euro/dollar exchange rate
with real-time data before, during, and after the financial crisis of
2008-2009. While all Taylor rule specifications outperform the random walk with
forecasts ending between 2007:Q1 and 2008:Q2, only the specification with both
estimated coefficients and the unemployment gap consistently outperforms the
random walk from 2007:Q1 through 2012:Q1. Several Taylor rule models that are
augmented with credit spreads or financial condition indexes outperform the
original Taylor rule models. The performance of the Taylor rule models is
superior to the interest rate differentials, monetary, and purchasing power
parity models. *International
Seminar on Macroeconomics 2012*, Volume 9, July 2013

The (Un)Reliability of Real-Time Output Gap Estimates with Revised Data

(with Onur Ince)

This paper investigates the differences between real-time
and ex-post output gap estimates using a newly-constructed international
real-time data set over the period from 1973:Q1 to 2007:Q2. We extend the
findings in Orphanides and van Norden (2002) for the *Economic Modeling*, 2013, 713-721

Median-Unbiased Estimation in DF-GLS Regressions and the PPP Puzzle

(with Claude Lopez and Chris Murray)

Using median-unbiased estimation
based on Augmented-Dickey-Fuller (ADF) regressions, recent research has
questioned the validity of Rogoff’s “remarkable
consensus” of 3-5 year half-lives of deviations from PPP. The confidence
intervals of these half-life estimates, however, are extremely wide, with lower
bounds of about one year and upper bounds of infinity. We extend
median-unbiased estimation to the DF-GLS regression of Elliott, Rothenberg, and
Stock (1996). We find that combining median-unbiased estimation with this
regression has the potential to tighten confidence intervals for the
half-lives. Using long horizon real exchange rate data, we find that the
typical lower bound of the confidence intervals for median-unbiased half-lives
is just under* *3
years. Thus, while previous confidence intervals for median-unbiased half-lives
are consistent with virtually anything, our tighter confidence intervals are
inconsistent with economic models with nominal rigidities as candidates for
explaining the observed behavior of real exchange rates and move us away from
solving the PPP puzzle. *Applied Economics*,
February 2013, 455-464

Taylor Rules and the Great Inflation

(with Alex
Nikolsko-Rzhevskyy)

Can
U.S. monetary policy in the 1970s be described by a stabilizing Taylor rule
when policy is evaluated with real-time inflation and output gap data? Using
economic research on the full employment level of unemployment and the natural
rate of unemployment published between 1970 and 1977 to construct real-time
output gap measures for periods of peak unemployment, we find that the Federal
Reserve did not follow a Taylor rule if appropriate measures are used. We
estimate ** **We also find that the
Federal Reserve responded too strongly to negative output gaps. *Journal
of Macroeconomics*, December 2012, 903-918

The Statistical Behavior of GDP after Financial Crises and Severe Recessions

(with Ruxandra Prodan)

Do
severe recessions associated with financial crises cause permanent reductions
in potential GDP, or does the economy return to its trend? If the economy
eventually returns to its trend, does the return take longer than the return
following recessions not associated with financial crises? We develop a
statistical methodology that is appropriate for identifying and analyzing
slumps, episodes that combine a contraction and an expansion, and end when the
economy returns to its trend growth rate. We analyze the Great Depression of
the 1930s for the U.S., severe and milder financial crises for advanced
economics, severe financial crises for emerging markets, and postwar recessions
for the U.S. and other advanced economies. The preponderance of evidence for
episodes comparable with the current U.S. slump is that, while potential GDP is
eventually restored, the slumps last an average of nine years. If this
historical pattern holds, the Great Recession that started in 2007:4 will not
ultimately affect potential GDP, but the Great Slump is not yet half over. *The B.E. Journal *of *Macroeconomics, Special Issue:
Long-Term Effects of the Great Recession*, October 2012, Article 2, 1-29* *

Convergence of Euro Area Inflation Rates

(with Claude Lopez)

(*Journal of International Money and Finance*, 2012, 1440-1458)

We
study the behavior of inflation rates among the 12 initial Euro countries in
order to test whether and when the group convergence initially dictated by the

(with
Tanya Molodtsova and Alex Nikolsko-Rzhevskyy)

*(Journal of Money, Credit, and Banking*, March-April
2011, 535-552)

This paper uses real-time data to
show that inflation and either the
output gap or unemployment, the variables which normally enter central banks’

Out-of-Sample Exchange Rate
Predictability with Taylor Rule Fundamentals

(with
Tanya Molodtsova)

(*Journal of International Economics*, 77, April 2009, 167-180)

Click here for the data and explanation of variable names.

Figures that are discussed but not included in
the text can be found here.

An extensive literature that studied the performance
of empirical exchange rate models following Meese and Rogoff’s
(1983a) 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 Rules with Real-Time Data: A Tale of Two
Countries and One Exchange Rate

(with
Tanya Molodtsova and Alex Nikolsko-Rzhevskyy)

(*Journal of Monetary Economics*, 55, October 2008, S63-S79)

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

Restricted
Structural Change and the Unit Root Hypothesis

(with Ruxandra Prodan)

(*Economic Inquiry*, October
2007, 834-853)

In a classic paper, Nelson and Plosser (1982) could not reject the unit root hypothesis in
favor of trend stationarity for 13 out of 14
long-term annual macro series. Subsequent studies, allowing for one or two
structural changes, have found more rejections with a broken trend stationary
alternative. Since these changes are defined to be permanent, the rejections do
not provide evidence of trend stationarity. We
propose new tests for a unit root in the presence of restricted structural
change. Allowing for two offsetting structural changes, we reject the unit root
null in favor of restricted trend stationarity at the
5% significance level for 6 out of 13 series.

(with Natalie Hegwood)

(*Southern Economic
Journal*, July 2007, 104-113)

Rapach (2002) could not reject the unit root null in favor of trend stationarity for four panels of international real GDP and real GDP per capita. Using panel methods that incorporate structural change, we reject the unit root null in favor of the alternative of trend stationarity with a one-time change in either the slope or in both the slope and the intercept for three of the four panels, the exception being the panel with both the fewest countries and the shortest span of data. We conclude that real GDP levels are best characterized as regime-wise trend stationary.

Convergence to Purchasing Power Parity at the Commencement of the Euro

(with Claude Lopez)

(*Review of International Economics*, February 2007, 1-16)

We investigate convergence towards
Purchasing Power Parity (PPP) within the Euro Zone and between the Euro Zone
and its main partners using panel data methods. We find strong rejections of
the unit root hypothesis, and therefore evidence of PPP, in the Euro Zone for
different numeraire currencies, as well as in the
Euro Zone plus the

Purchasing
Power Parity and Country Characteristics: Evidence from Panel Data Tests

(with Joseph Alba)

(*Journal of Development Economics*,
January 2007, 240-251)

We examine long-run purchasing power parity (PPP) using panel data methods
to test for unit roots in US dollar real exchange rates of 84 countries. We
find stronger evidence of PPP in countries more open to trade, closer to the

Additional
Evidence of Long Run Purchasing Power Parity with Restricted Structural Change

(with
Ruxandra Prodan)

(*Journal of Money, Credit, and Banking*,
August 2006, 1329-1349)

We investigate two alternative versions of Purchasing Power Parity (PPP):
reversion to a constant mean in the spirit of

The Panel Purchasing Power Parity Puzzle

(*Journal of Money, Credit, and Banking*,
March 2006, 447-467)

Does long-run purchasing power parity 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 specification that incorporates PPP restricted structural change.

(with Jomana Amara)

(*Applied Financial Economics*,
January 2006, 29-39)

We test for Purchasing Power Parity in post-Bretton-Woods real exchange rate data from twenty developed countries using univariate tests and covariate augmented versions of the Augmented Dickey-Fuller (CADF) and feasible point optimal (CPT) unit root tests. The covariates are a combination of stationary variables - inflation, monetary, income, and current account. We perform a cross method comparison of the results. We find very strong evidence of PPP using the CPT test, rejecting the unit root null for 12 out of the 20 countries at the 5% significance level or better, and 6 more at the 10% level. We find much less evidence of PPP with the CADF and univariate tests.

Do Panels Help Solve the Purchasing Power Parity Puzzle?

(with Christian Murray)

(*Journal of Business and Economic Statistics*,
October 2005, 410-415)

While Rogoff (1996) describes the “remarkable consensus” of 3 to 5 year half-lives of purchasing power parity deviations among studies using long-horizon data, recent papers using panel methods with post-1973 data report shorter half-lives of 2 to 2.5 years. These studies, however, do not use appropriate techniques to measure persistence. We extend median-unbiased estimation methods to the panel context, calculate both point estimates and confidence intervals, and provide strong evidence confirming Rogoff’s original claim. While panel regressions provide more information on the persistence of real exchange shocks than univariate regressions, they do not help solve the purchasing power parity puzzle.

Panel Evidence of Purchasing Power Parity Using Intranational and International Data

(with Sarah Culver)

(*International Macroeconomics: Recent
Developments*, Nova Science Publishers, 2006, 39-51)

We investigate purchasing power parity (PPP) with CPI data for Canadian and

The Purchasing Power Parity Puzzle is Worse than You Think

(with Christian Murray)

(*Empirical Economics*, October 2005,
783-790)

The “purchasing power parity puzzle” is the difficulty of reconciling very
high short-term volatility of real exchange rates with very slow rates of mean
reversion. The strongest evidence of
slow mean reversion comes from least squares estimates of first-order
autoregressive models of the long-horizon dollar-sterling real exchange
rate. Using median-unbiased estimation
methods, we show that these methods *underestimate*
the half-lives of PPP deviations, and thus *overestimate*
the speed of mean reversion. When the specification is amended to allow for
serial correlation, the speed of mean reversion falls even further. This makes
resolution of the purchasing power parity puzzle more problematic.

State of the Art Unit Root Tests and Purchasing Power Parity

(with Claude Lopez and Christian Murray)

(*Journal of Money, Credit, and Banking*, April 2005, 361-369)

Although the question of whether
Purchasing Power Parity (PPP) holds in the long run has been extensively studied,
the answer is still controversial. Some of the strongest evidence is provided
by Taylor (2002), who concludes that long-run PPP held over the twentieth
century. We argue that this conclusion is quite sensitive to the use of
sub-optimal lag selection in unit root tests. Using superior lag selection
methods, we find that long run PPP held for the real exchange rates of only 9
out of the 16 industrialized countries in

(with Ruxandra Prodan)

(*Journal of Money, Credit, and
Banking*, June 2004, 423-427)

Unit Roots, Postwar Slowdowns and Long-Run Growth: Evidence From Two Structural Breaks

(with Dan Ben-David and Robin Lumsdaine)

(*Empirical Economics*, February 2003, 303-319)

This paper provides evidence on the unit root hypothesis and long-term growth by allowing for two structural breaks. We reject the unit root hypothesis for three-quarters of the countries n approximately 50% more rejections than in models that allow for only one break. While about half of the countries exhibit slowdowns following their postwar breaks, the others have grown along paths that have become steeper over the past 120 years. The majority of the countries, including most of the slowdown countries, exhibit faster growth after their second breaks than during the decades preceding their first breaks. (Revised: October 2001)

(P. Aghion, R. Frydman,
J. Stiglitz and M. Woodford, eds,
*Knowledge, Information, and Expectations in Modern Macroeconomics: In Honor
of Edmund S. Phelps*, Princeton University Press, 2003, p. 183-187)

The Great Appreciation, the Great Depreciation, and the Purchasing Power Parity Hypothesis

(*Journal of International Economics,* May 2002, 51-82)

Although there has been much recent work on Purchasing Power Parity (PPP), neither univariate nor panel methods have produced strong rejections of unit roots in U.S. dollar real exchange rates for industrialized countries during the post-1973 period. We investigate the hypothesis that these non-rejections can be explained by one episode, the large appreciation and depreciation of the dollar in the 1980s, by developing unit root tests which account for this event and maintain long-run PPP. Using panel methods, we can strongly reject the unit root null for those countries that adhere to the typical pattern of the dollar’s rise and fall.

The Purchasing Power Parity Persistence Paradigm

(with Christian J. Murray)

(*Journal of International Economics*, January 2002, 1-19)

Rogoff (1996) describes the "remarkable consensus" of 3-5 year half-lives of purchasing power parity deviations among studies using long-horizon data. These studies, however, focus on rejections of unit roots in real exchange rates and do not use appropriate techniques to measure persistence. Our half-life estimates explicitly account for serial correlation, sampling uncertainty, and, most importantly, small sample bias. Calculating confidence intervals as well as point estimates for long-horizon and post-1973 data, we find that, even though most of the point estimates lie within the 3-5 year range, univariate methods provide virtually no evidence regarding the size of the half-lives.

The Choice of Numeraire Currency in Panel Tests of Purchasing Power Parity

(with Hristos Theodoridis)

(*Journal of Money, Credit, and Banking*, August 2001, 790-803)

We investigate the implications of the choice of numeraire currency on panel tests of Purchasing Power Parity under the current regime of flexible exchange rates by conducting panel unit root tests with twenty-one different base currencies. We show that the conditions necessary for numeraire irrelevancy are not supported empirically, and that the choice of numeraire currency can and does matter for PPP. The evidence of PPP is stronger for European than for non-European base currencies. Distance between the countries and volatility of the exchange rates are the most important determinants of the results.

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