Monetary Policy Shocks and Exchange Rate Fluctuations in Kenya.
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Date
2024
Authors
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Journal ISSN
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Publisher
Daystar University, School of Business and Economics
Abstract
This study investigated the effect of monetary policy shocks on exchange rate fluctuations in Kenya from 2000 to 2023, a period marked by significant economic challenges, including the depreciation of the Kenyan shilling. The primary objectives were to analyse historical changes in monetary policy, assess trends in exchange rates, and analyse the effect of monetary policy shocks on exchange rate fluctuations. Grounded on Interest Rate Parity theory, the research utilized a positivist approach and explanatory research design, with quarterly time series data. Using a Structural Vector Auto-regression (SVAR) model, key findings revealed an upward trend in money supply (M2), reflecting expansionary policies aimed at stimulating growth. In contrast, the Central Bank Rate (CBR) showed significant volatility during inflationary periods driven by global oil prices. CBR shocks initially led to a temporary appreciation of the nominal exchange rate (NER), while M2 shocks caused short-term depreciation, highlighting the complex interplay between these variables. Variance decomposition analysis indicated that contributions from both CBR and M2 to NER fluctuations increased over time. The balance of trade emerged as a pivotal factor influencing exchange rate fluctuations, especially during external shocks like the 2008 financial crisis. The real exchange rate (RER) exhibited less fluctuations due to inflation differentials, reinforcing the need for effective inflation management strategies. These findings highlighted the need for the Central Bank of Kenya (CBK) to adopt a targeted monetary policy with clear M2 growth targets and timely CBR adjustments. Stable exchange rates are key for promoting business, trade, and investment, while effective communication is essential for managing market expectation
Description
MASTER OF SCIENCE in Economics
Keywords
Monetary policy shocks, Exchange rate fluctuations, Depreciation of the Kenyan shilling
Citation
Chacha, C. B. (2024). Monetary Policy Shocks and Exchange Rate Fluctuations in Kenya. Daystar University, School of Business and Economics.