Exchange Rate Fluctuations and Macroeconomic Stability in Kenya

Abstract

This study focused on exchange rate fluctuations and macroeconomic stability in kenya from 1980 to 2024, a time characterized by exchange rate fluctuations coinciding with weak macroeconomic stability escalated by both domestic and external vulnerabilities.The main research objectives were to assess trend analysis of exchange rate fluctuations, examine Granger Causality between exchange rate fluctuations and macroeconomic stability in Kenya and analyzing relationships.Purchasing Power Parity Theory served as the anchor theory, supported by Mundell Mundell-Fleming Model and the New Keynesian Theory. Pragmatist philosophy guided the research while a quantitative approach was adopted combining Correlational and Descriptive design. Annual times series data was analyzed using the Structural Vector Autocorrelation Model.The results of trend analysis cofficient was 2.707 which was statistically significant which indicated depreciation of local currency aganist foreign currency over time. The findings showed that exchange rate significantly Granger causes fiscal deficit (P=0.225) whereas fiscal deficit Granger caused GDP growth rate (P=0.0456) and interest rates (P=0.003).The Impulse Response Functions revealed that due to One standard deviation shock from bilaterial exchange rate, causes inflation rate rises up, fiscal deficit soars upwards and GDP growth declines.Variance Decomposition proved that most variables are self driven by own past shocks and exchange rate shocks impacts inflation,fiscal balance,and interest rate levels.The research demonstrated that exchange rate fluctuations exchange rate fluctuations do interfere with macro stability of Kenya,such as, the strike inflation, interest rates and fiscal deficit .It goes without saying in the short-term, but the economy gradually stabilizes itself in the long-term, as though it is partially correcting itself. Generally, the research findings calls for a cordinated policy interventions linking fiscal policy and monetary policy, as well as intergrating exchange rate signals in inflation targeting framwork.This macro, policy adjustments ought to be aligned with Kenya Vision, 2030 of low inflation, low interest rate and sustainable fiscal balance in order to achieve equitable gowth and economic transformation through stability.