DETERMINANTS OF EQUILIBRIUM REAL EXCHANGE RATE AND IT'S MISALIGNMENT IN KENYA 2000-2016: AN AUTOREGRESSIVE DISTRIBUTED LAG APPROACH
Keywords:
misalignment, dynamic, fundamentalsAbstract
Purpose: This paper investigates the determinants of Kenya's real exchange rate and determine the real exchange rate and its misalignment from the long run equilibrium level using quarterly data covering 2000 - 2016.
Methodology The Behavioral Equilibrium Exchange Rate approach to determine the extent of exchange rate misalignment is adopted. The study adopted a dynamic Auto Regressive Distributed Lag bounds testing modeling approach.
Findings: The estimation results show that, net foreign assets, productivity, world oil prices, trade openness and terms of trade influence Kenya's long-run real exchange rate. However, government expenditure, and tax revenue were found to have no effect on the real exchange rate. The estimation results show that the real exchange rate is driven by the economic fundamentals and in terms of misalignment the exchange rate is overvalued to a maximum of 5.9 percent and undervalued up to 5.2 percent.
Unique contribution to theory, practice and policy: Kenya's exchange rate is closely aligned to its long run fundamentals and the adoption of the floating exchange rate regime achieved one of the intended purpose namely reduction of exchange rate misalignment associated with overvaluation. The monetary authority should ensure the exchange rate remains stable and within this range while ensuring the fundamentals that can lead to overvaluation are monitored.
Downloads
References
Balassa, B., (1964). The Purchasing-Power Parity Doctrine: A Reappraisal. Journal of Political Economy Vol. 72, No. 6 (Dec., 1964), pp. 584-596
Belloumi, M. (2014). The Relationship Between Trade, FDI and Economic Growth in Tunisia: An Application of the Autoregressive Distributive Lag Model. Economic Systems, 38 (2): 269-287.
Chen, X., & McDonald, R. (2012). Measuring the Euro-Dollar Permanent Equilibrium Exchange Rate using the Unobserved Components Model. Stirling Economics Discussion Paper 2014-12.
Clark, B. P., & McDonald, R. (1999). Exchange Rates and Economic Fundamentals: A methodological comparison of BEERs and FEERs. IMF, WP/98/67.
Coudert, V., & Couharde., C. (2008). Currency Misalignments and Exchange Rate Regimes in Emerging and Developing Countries. CEPII.
Driver, R.L. & Westaway, P.F. (2004). Concepts of Equilibrium Exchange Rates. Working Paper 248, Bank of England. London.
Edwards, S., (1997). The Mexican Peso Crisis: How Much Did We Know? When Did We Know It? National Bureau of Economic Research. Working Paper 6334.
Engel. C. (2011). Cureency Misalignment and Optimal Monetary Policy: A Reexamination. American Economic Review 101: 2796-2822.
Engle; R. & Granger, C., (1987). Co-Integration and Error Correction: Representation, Estimation, and Testing. Econometrica, Vol. 55 (2) pp. 251-276.
Eyquem, A., Bouakez, H., (2012). Government Spending, Monetary Policy, and the Real Exchange Rate. (Working paper 1139). Groupe D'analyse Et De Thorie Économique Lyon " St Étienne
Farhani, S. (2012). Tests for Parametric Instability. Theoretical Study and Empirical Analysis on Two Types of Models (ARMA model and Market Model). International Journal of Economics and Financial Issues: 2(3) 246-266.
Greene, H.W. (2002). Econometric Analysis. Fifth Edition. Prentice Hall, Upper River Saddle, New Jersey.
Gujarati, D. N. (2004). Basic Econometrics, Fourth Edition, McGraw-Hill. United States Military Academy, West Point. USA.
Harvey, Simon & Sedegah, Kordzo. (2008). Import demand in Ghana: Structure, behaviour and stability. African Journal of Economic Policy. 15. 89-120. 10.4314/ajep.v15i2.44940.
Ibrahim, W. (2014). Real Exchange Misalignment and Trade Flows in Nigeria (1960-2013). Journal of Academic Research in Economics, Vol 6 (3).
Imam, P. and Minoiu, C. (2011). The Equilibrium Exchange Rate of Mauritius: Evidence from Two Structural Models. IMF 2011.
Jordaan, A.C., & Eita, J.H.(2012) Real Exchange Rate Misalignment and Economic Performance in an Emerging Economy: Evidence from South Africa. University of Pretoria.
Kim, S. E., (2008). Exchange Rates and Fundamentals Under Adaptive Learning. Journal of Economic Dynamics & Control. doi:10.1016/j.jedc.2008.10.002
Kiptoo, C (2007), Real Exchange Rate Volatility, and misalignment in Kenya, 1993-2003, Assessment of its impact on International Trade, and investments. Unpublished Ph.D Thesis, University of Nairobi.
Kiptui, M. C. & Kipyegon, L. (2008). External Shocks and Real Exchange Rate Movements in Kenya. The 13th Annual Conference on Econometric Modelling in Africa 9-11 July 2008: University of Pretoria,
Kiptui, M.C. & Ndirangu, L. (2015). Determinants of Equilibrium Real Exchange Rate and its Misalignment in Kenya: A Behavioral Equilibrium Exchange Rate Approach, MPRA Paper No. 70542, https://mpra.ub.uni-muenchen.de/70542/
Kubota, M. (2009). Real Exchange Rate Misalignments. Unpublished PhD Thesis . University of York
Lugaiyamu, L., (2015). Determinants of Exchange Rate in Tanzania. (unpublished). Uppsala University
McDonald, R. (1997). What Dtermines Real Exchange Rates? The Long and Short of It. IMF Working Paper. WP/97/21.
Musyoki, D., Pokhariyal G. P., & Pundo, M. (2012). Real Exchange Rate Equilibrium and Misalignment in Kenya. Journal of Business Studies Quarterly, Vol 3, No, 4, 24-42
Mwega, F., M. (2014). Real Exchange Rate Misalignment and Implications for the Nominal Exchange Rate Level in Kenya in 2012. Central Bank of Kenya.
Ndavi, T. W. (2012). The Effects of Real Exchange Rate Misalignment on Economic Growth: A Case Study of Kenya. Unpublished MA Thesis, Nelson Mandela University.
Ndung'u, N.S. (1999). Monetary and Exchange Rate Policy in Kenya. AERC Research Paper No. 94, March 1999.
Ngoma, A. L., Ismail, N. W., & Yusop, Z. (2016). An Analysis of Real Oil Prices and Real Exchange Rates in Five African Countries: Applying Symmetric and Asymmetric Cointegration Models. Foreign Trade Review, 51(2), 162-179. https://doi.org/10.1177/0015732515625718
Nyamunga P. A., (2017). Impact of Oil Prices on the Exchange Rate In Kenya. (Unpublished) Strathmore University.
Palić, I. DumiÄić, K. & Å prajaÄek, P. (2014). Measuring real exchange rate misalignment in Croatia: cointegration approach. Croatian Operational Research Review. CRORR 5(2014), 135-148
Sidek N.,Z. (2011). Malaysia: How Much Exchange Misalignment is Detrimental to Exports?. International Conference in Economics, Trade and Development. IPEDR Vol 7.
Sims, C.A., Stock, J.H., and Watson, M.W. (1990). Inference in Linear Time Series Models With Some Unit Roots. Econometrica: 58(1) 113-144.
Tensay, T.M., (2006). Measuring the Real Exchange Rate Misalignment of Ethiopia: A Dynamic OLS Approach. Ethiopian Journal of Economics Vol XV (1).
Toulaboe, A. (2006). Real Exchange Rate Misalignments and Economic Growth in Developing Countries. Southwestern Economic Review, 33: 57-74.
World Bank (2010). Can Real Exchange Rates Undervaluation Boost Exports and Growth in Developing Countries? Yes, but not for Long. Poverty Reduction and Economic Management Network (PREM). Issue 10.
Wu, H., (1999). Testing for the Fundamental Determinants of the Long-Run Real Exchange Rate: The Case of Taiwan. University of Chicago. Vol 7 (377 - 402)
Downloads
Published
How to Cite
Issue
Section
License
Authors retain copyright and grant the journal right of first publication with the work simultaneously licensed under a Creative Commons Attribution (CC-BY) 4.0 License that allows others to share the work with an acknowledgment of the work's authorship and initial publication in this journal.
