A Monetary Approach to Exchange Rate Dynamics in Low-Income Countries: Evidence from Kenya

Boaz Nandwa and Ramesh Mohan ()

MPRA Paper from University Library of Munich, Germany

Abstract: The flexible price monetary model assumes that both the purchasing power parity (PPP) and uncovered interest parity (UIP) hold continuously. In addition, the model posits that money market equilibrium exists, which helps to determine the exchange rate. This paper explores exchange rate determination in low-income economies by applying a monetary model to Kenya to examine the exchange rate dynamics in a post-float exchange rate regime. We apply a multivariate cointegration and error correction model (ECM) to investigate whether the long-run exchange rate equilibrium and the rate of adjustment to the long-run equilibrium hold, respectively. Finally, we evaluate the relative performance of ECM versus a random walk framework in the out-of-sample forecasting. We find that the random walk performs better than the restricted model.

Keywords: Exchange rate; volatility; regime changes; Kenyan Shilling (search for similar items in EconPapers)
JEL-codes: C32 C53 E58 F31 (search for similar items in EconPapers)
Date: 2007-11-02
New Economics Papers: this item is included in nep-afr, nep-cba, nep-ifn, nep-mac and nep-mon
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Persistent link: https://EconPapers.repec.org/RePEc:pra:mprapa:5581

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