The Influence of Monetary Policy Shocks on Exchange Rate Fluctuations: Devising a Model for Enhancing Currency Stability

Michael Takudzwa Pasara and Gondani Hlangani
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Michael Takudzwa Pasara: London School of Economics and Political Science
Gondani Hlangani: University of Zimbabwe, and Ministry of Finance

Chapter Chapter 6 in Public Finance Management in the Development Matrix of the Global South, 2025, pp 91-125 from Springer

Abstract: Abstract This study aimed to investigate the impact of monetary policy shocks on exchange rates and develop a model for enhancing currency stability in Zimbabwe. Utilising secondary monthly time series data from January 2020 to June 2023, the study employed Granger causality tests and the Vector Error Correction Model (VECM) to analyse the relationships between interest rates, money supply, and exchange rates. Results revealed a significant Granger causality effect from money supply to exchange rates, emphasising the crucial role of broad money in shaping short-term dynamics. However, the impact of interest rate changes on exchange rates was found to be limited in the short term. The study constructed a robust VECM framework, grounded in lag structures and feedback loops, providing practical insights for policymakers. The model highlighted the responsiveness of exchange rates to changes in broad money and interest rates. Recommendations include having a balanced approach to managing broad money supply, prioritising stable and attractive interest rates for sustained economic growth, and instituting the error correction mechanism (ECM) for prompt adjustments to deviations from long-term equilibrium. Policymakers are advised to view the model as adaptive, requiring continuous refinement to remain relevant and effective in navigating the complex economic landscape.

Keywords: Monetary policy; Exchange rates; Money supply; Inflation; Zimbabwe (search for similar items in EconPapers)
Date: 2025
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Persistent link: https://EconPapers.repec.org/RePEc:spr:aaechp:978-3-032-00525-0_6

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DOI: 10.1007/978-3-032-00525-0_6

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