Exchange Rate Pass-through Dynamics: VAR Evidence for Kenya

Abstract

A VAR framework with exogenous variable is considered to analyse the exchange rate pass-through dynamics in Kenya. Monthly time series data from January 2006 to December 2022 is used. Six endogenous variables namely; US dollar exchange rate, broad money supply, total import, 20 Nairobi stock exchange share index, consumer price index and 91 days treasury bond rate sourced from the central bank of Kenya were considered. Global food price index and oil prices per barrel sourced from statista and Murban Adnoc respectively are the exogenous variables. Unit root test is first performed to test for stationary in line with VAR assumptions. Oil price and total import are the only stationary variables, while the other variables are of integrated order 1. Secondly, a VARX (2,0) is estimated, which is statistically significant at 5% level. Thirdly, Granger causality test is performed, that provide evidence of causality for 20 Nairobi stock exchange share index, consumer price index and broad money supply with respect to other endogenous variables. In addition, VARX(2,0) is converted to MA(2) to develop US dollars impulse response function. There exist high level of volatility for all variables. Finally, a forecast error variance decomposition following Cholesky decomposition shows significant proportion of variance explained by other variables respectively. Kenya’s policy makers need to build strong framework for monetary policy and exchange rate control measures in safeguarding the performance of macroeconomic indicators.