Econometric Modelling of Short Run Parsimonious and Long Run Co-integrated Real Exchange Rate Determinants in Kenya

Bunde Aggrey Otieno Faculty of Business Studies Department of Business Administration Chuka University, P.O. Box 109 – 60400, Chuka, Kenya.

##article.subject##: Econometric, Modeling, Exchange Rate, Kenya.

##article.abstract##

country’s exchange rate is an important determinant of the growth of its cross border trading and it serves as a measure of international competitiveness. Appreciation of the shilling real exchange rate in Kenya attracted public attention in the last decades, especially from exporters and importers who have argued that the weakening shilling is eroding their competitiveness. The objective of this study was to investigate parameters influencing real exchange rate in Kenya. The data comprised of annual time series data for Kenya over the sample period 1960 to 2010.The study was guided by Montiel’s theory.In this theoretical model, economy’s endogenous variables are determined by predetermined and exogenous policy variables.Predetermined variables are endogenous variables that change slowly over time and exogenous policy variables include fiscal and monetary policy variables, trade policies and variables under the control of domestic authorities. The study adopted Error Correction Model, because of its ability to induce flexibility by combining the short run dynamic and long run equilibrium model in a unified system. Inferential statistics were applied using PC Give, unit root, co integration and granger causality tests were done prior to estimation. The use of cointegration technique allowed the study to capture the equilibrium relationship between non-stationary series within a stationary model. The results of long run co-integrated equilibrium and short-run parsimonious real exchange rate models revealed that real exchange rate is influenced by internal factors such as aid, government expenditure, technological progress, nominal exchange rate and commercial policy stance. External factors proxied by terms of trade also tend to play a critical role as they lead to real exchange rate depreciation. The study concluded that policy management need to focus on ensuring the prevalence of sound macroeconomic fundamentals and effectively target and manage all variables influencing long run behavior of real exchange rate in Kenya.

Author Biography

Bunde Aggrey Otieno, Faculty of Business Studies Department of Business Administration Chuka University, P.O. Box 109 – 60400, Chuka, Kenya.

Bunde Aggrey Otieno received B.Sc. Degree and M.A. Degree in Economics from Moi University in the year 2007 and 2013, respectively. He has served as a Research associate with Kenya Institute for Public Policy Research and Analysis (KIPPRA), Kenya National Bureau of Statistics (KNBS), Centers for Disease Control and Prevention (CDC KEMRI/CDC Atlanta Georgia) and as an Economist with State Department of Agriculture, he has taught as a part time lecturer in the department of Economics of Moi University, Kenya, Department of Management science, University of Eldoret, Kenya and Faculty of Commerce, Kisii University, Kenya. In July 2014 he was appointed as a Young Professional by the Kenya Institute for Public Policy Research and Analysis (KIPPRA). Currently he is pursuing PhD in Economics and serving as a lecturer in Economics in the Department of Business Administration of Chuka University, Kenya. I have published articles in a number of International Journals that includes the African Journal of Education Science and Technology (AJEST), the International Journal of Sciences Basic and Applied Research (IJBAR), International Journal of Sciences and Research (IJSR). My research interests are mainly on Public sector economics, Monetary Economics, Energy Economics, Financial Economics, Environmental and Natural Resource Economics, International Trade, Agricultural Economics and Infrastructural Economics

References

Bah, I. and Amusa, H.A. (2003). Real exchange rate volatility and foreign trade: evidence from South Africa’s exports to the United States. The African Finance Journal, 5, 2: 1-20.

Banerjee, A. (2003). Co-integration, error correction, and the econometric analysis of non-stationary data. Oxford [u.a.: Oxford Univ. Press.

Edwards, S. (1989). Real exchange rates, devaluation and adjustment: exchange rate policy in developing countries. Cambridge: The MIT Press.

Edwards, S. and Savastano, M.A.(1999). Exchange rates in emerging economies: what do we know? What do we need to know? Available: http://ideas.repec.org/s/nbr/nberwo.html. 25/1/2013.

Elbadawi A and R. Soto. (1995). Theory and Empirics of Real exchange rates in Sub-Saharan Africa and other Developing countries, Preliminary report part of World Bank project.

Engle, R.F. and C.W.J.Granger.(1987). Co-integration and error correction. Representation, estimation, and testing. Econometrica, vol. 55, no. 2: 251–76.

Granger, C.W.J. (1969). Investigating Causal Relation by Econometric and Cross-sectional Method. Econometrica, 37: 424 – 438.

Gujarati, D.N. (2003). Basic Econometrics. 4Th Ed. New York: McGraw – Hill Inc.

Johansen, S. and K. Juselius. (1990). Maximum Likelihood Estimation and Inferences on Cointegration: with application to the demand for money. Oxford Bulletin of Economics and Statistics, Vol. 52: 169 – 210.

Kennedy, P. (2003). A guide to econometrics. Cambridge, Mass: MIT Press.

Kiptui, M. and Kipyegon, L. (2008). External Shocks and Real Exchange Rate Movements In Kenya. Annual Conference on Econometric Modeling in Africa. South Africa: University of Pretoria.

Maddala, G. S., & Kim, I.-M. (1998). Unit roots, cointegration and structural change. Cambridge: Cambridge Univ. Press.

Montiel, P. J. (2003). Macroeconomics in emerging markets. Cambridge: Cambridge University Press.

Ndung’u, N.S. (2008). The exchange rate and interest rate differential in Kenya: a monetary and fiscal dilemma. KIPPRA Discussion Paper No. 2. Nairobi: Kenya Institute for Public Policy Research and Analysis.

Pollin, R. and Heintz, J. (2007). Expanding Descent Employment in Kenya: The Role of Monetary Policy, Inflation Control and the Exchange Rate. International Poverty Center Country study No. 6.

##submissions.published##

2018-04-04

##issue.issue##

##issue.vol## 3 ##issue.no## 3 (2017)

##section.section##

Articles