Economic Determinants of Exchange Rate Volatility in Kenya.

Abstract

The role of the exchange rate channel in the transmission of monetary policy has become more important due to globalization and the widespread use of floating exchange rate systems. Exchange rates are widely utilized by governments across the globe as a pivotal monetary policy instrument to exert influence over diverse economic and financial issues. It is of utmost importance to comprehend the factors and procedures that determine and regulate exchange rates. Nevertheless, numerous emerging economies, such as Kenya, face difficulties in achieving stability in their currency exchange rates. Forecasting future exchange rates is a difficult task for policymakers due to the intricate interaction of macroeconomic, speculative, and economic anticipation elements. This study aims to fill the lack of extensive research on the economic factors that influence the fluctuation of currency rates in Kenya. The study seeks to give valuable insights for policymakers, investors, and market participants by analyzing the effects of foreign direct investment, inflation rates, and the balance of payments on exchange rates. The study explores the complex dynamics of exchange rate fluctuations by using a quantitative research strategy and applying techniques such as Vector Autoregression (VAR) model analysis, Granger causality testing, and regression analysis. The results demonstrate notable associations between exchange rates and macroeconomic variables, providing insight into the factors that contribute to fluctuations in the exchange rate in Kenya. This study enhances the current body of knowledge by giving a detailed comprehension of the factors that influence exchange rates. It also offers significant perspectives for policymakers and stakeholders in effectively managing exchange rate risks and promoting economic stability.