The Taylor Rule, Wealth Effects and the Exchange Rate

Abstract

In this study, we develop the Taylor rule and Taylor rule-based exchange rate models that consider wealth effects as represented by both asset prices and asset wealth. Using data for Australia, Sweden, the UK and the USA, we find that effects of asset prices and wealth on the Taylor rule vary depending on the country and on the form that wealth takes. Out-of-sample forecasting capacities of the wealth-augmented Taylor rule model and Taylor rule-based exchange rate model outperform conventional models and random walk theories for these countries.