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Real interest rate differentials and the real exchange rate: Evidence from four African countries

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  • Reinhart, Carmen
  • Asea, Patrick

Abstract

During the early 1990s much has been written about the return of foreign private capital to many of the larger Asian and Latin American countries. However, until 1992 there was little evidence that countries in sub-Saharan Africa were participating in this phenomenon. In this paper we use variance decompositions and impulse responses from vector autoregressions to shed light on the possible causes and consequences of capital inflows to four countries: Ghana, Kenya, Uganda, and Zimbabwe. We use trend-cycle decompositions to provide evidence linking the appreciation of the real exchange rate to periods of heavy capital inflows. We show that domestic real interest rates have played an important role in explaining the recent behavior of the real exchange rate. In particular, we trace the rise in domestic nominal and real interest rates to policies designed to liberalize the domestic financial sector and attempts to curb the monetary expansion associated with the capital inflows through sterilized intervention.

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Bibliographic Info

Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 13357.

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Date of creation: 1995
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Handle: RePEc:pra:mprapa:13357

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Keywords: capital flows real exchange rate interest rates;

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References

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  1. Calvo, Guillermo A. & Reinhart, Carmen M. & Vegh, Carlos A., 1995. "Targeting the real exchange rate: theory and evidence," Journal of Development Economics, Elsevier, vol. 47(1), pages 97-133, June.
  2. Carmen Reinhart & Guillermo Calvo & Leonardo Leiderman, 1992. "Capital Inflows to Latin America," IMF Working Papers 92/85, International Monetary Fund.
  3. Bernanke, Ben S., 1986. "Alternative explanations of the money-income correlation," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 25(1), pages 49-99, January.
  4. Carmen M. Reinhart & Peter Wickham, 1994. "Commodity Prices: Cyclical Weakness or Secular Decline?," IMF Staff Papers, Palgrave Macmillan, vol. 41(2), pages 175-213, June.
  5. Asea, Patrick K & Mendoza, Enrique G, 1994. "The Balassa-Samuelson Model: A General-Equilibrium Appraisal," Review of International Economics, Wiley Blackwell, vol. 2(3), pages 244-67, October.
  6. Carlos F. Diaz-Alejandro, 1984. "Latin American Debt: I Don't Think We Are in Kansas Anymore," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 15(2), pages 335-403.
  7. Vicente Galbis, 1993. "High Real Interest Rates Under Financial Liberalization," IMF Working Papers 93/7, International Monetary Fund.
  8. Reinhart, Carmen & Dunnaway, Steve, 1996. "Dealing with capital inflows: Are there any lessons?," MPRA Paper 13764, University Library of Munich, Germany.
  9. Peter Wickham & Carmen Reinhart, 1994. "Commodity Prices," IMF Working Papers 94/7, International Monetary Fund.
  10. Ghura, Dhaneshwar & Grennes, Thomas J., 1993. "The real exchange rate and macroeconomic performance in Sub-Saharan Africa," Journal of Development Economics, Elsevier, vol. 42(1), pages 155-174, October.
  11. Blanchard, Olivier Jean, 1989. "A Traditional Interpretation of Macroeconomic Fluctuations," American Economic Review, American Economic Association, vol. 79(5), pages 1146-64, December.
  12. Beveridge, Stephen & Nelson, Charles R., 1981. "A new approach to decomposition of economic time series into permanent and transitory components with particular attention to measurement of the `business cycle'," Journal of Monetary Economics, Elsevier, vol. 7(2), pages 151-174.
  13. Reinhart, Carmen & Calvo, Guillermo & Leiderman, Leonardo, 1994. "The capital inflows problem: Concepts and issues," MPRA Paper 13902, University Library of Munich, Germany.
  14. Elbadawi, Ibrahim A. & Soto, Raimundo, 1994. "Capital flows and long-term equilibrium real exchange rates in Chile," Policy Research Working Paper Series 1306, The World Bank.
  15. Miller, Stephen M., 1988. "The Beveridge-Nelson decomposition of economic time series : Another economical computational method," Journal of Monetary Economics, Elsevier, vol. 21(1), pages 141-142, January.
  16. Montiel, P.J., 1995. "Financial Policies and Economic Growth: Theory, Evidence and Country-Specific Experience from Sub-Saharan Africa," Papers 18s, African Economic Research Consortium.
  17. Harvey, A C, 1985. "Trends and Cycles in Macroeconomic Time Series," Journal of Business & Economic Statistics, American Statistical Association, vol. 3(3), pages 216-27, June.
  18. Cuddington, John, 1989. "Commodity Export Booms in Developing Countries," World Bank Research Observer, World Bank Group, vol. 4(2), pages 143-65, July.
  19. Reuven Glick & Ramon Moreno, 1994. "Capital flows and monetary policy in East Asia," Pacific Basin Working Paper Series 94-08, Federal Reserve Bank of San Francisco.
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Citations

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Cited by:
  1. Njuguna S. Ndung'U & Rose W. Ngugi, 1999. "Adjustment and liberalization in Kenya: the financial and foreign exchange markets," Journal of International Development, John Wiley & Sons, Ltd., vol. 11(3), pages 465-491.
  2. Ndung'u, N.S., 1999. "Monetary and Exchange Rate Policy in Kenya," Papers 94, African Economic Research Consortium.
  3. Elbadawi, Ibrahim A & Soto, Raimundo, 1997. "Real Exchange Rates and Macroeconomic Adjustment in Sub-Saharan Africa and Other Developing Countries," Journal of African Economies, Centre for the Study of African Economies (CSAE), vol. 6(3), pages 74-120, Supplemen.
  4. Reinhart, Carmen M & Reinhart, Vincent R, 1999. "On the Use of Reserve Requirements in Dealing with Capital Flow Problems," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 4(1), pages 27-54, January.
  5. Louis Kasekende & Damoni Kitabire & Matthew Martin, 1998. "Capital Inflows and Macroeconomic Policy in Sub-Saharan Africa," Macroeconomics 9809005, EconWPA.

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