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Exchange Rate Fluctuations and Macroeconomic Stability in Kenya: A SVAR Model

Author

Listed:
  • Nyekwel, Philip

    (Daystar University)

  • Chesang, Laban

    (Daystar University)

  • Musau, John

    (Daystar University)

  • Kithandi, Charles Katua

    (Daystar University)

Abstract

This study examines the dynamic relationship between exchange rate fluctuations and macroeconomic stability in Kenya over the period 1980–2024, a period characterized by persistent currency depreciation and fragile macroeconomic conditions. Anchored in Purchasing Power Parity (PPP) theory and supported by the Mundell-Fleming Model and New Keynesian Theory, the study adopts a pragmatist philosophy and employs a quantitative, descriptive-correlational research design. Annual time-series data on six macroeconomic variables — bilateral exchange rate (BIER), inflation rate (INFLR), GDP growth rate (GDPGR), net balance of payments (NBOP), interest rate (IR), and fiscal deficit (FD) — were analysed using the Structural Vector Autoregressive (SVAR) model, complemented by Granger causality tests, impulse response functions (IRFs), and forecast error variance decomposition (FEVD). Trend analysis yielded a coefficient of 2.707 (p = 0.000), confirming a statistically significant and sustained depreciation of the Kenyan shilling. Granger causality results established that exchange rate fluctuations significantly precede fiscal deficit changes (p = 0.0225), while fiscal deficit strongly Granger-causes interest rates (p = 0.0003) and GDP growth (p = 0.0456). IRF analysis demonstrated that a one-standard deviation exchange rate shock triggers an immediate rise in inflation, a short-term contraction in GDP growth, worsening of the balance of payments, and a tightening monetary policy response. Variance decomposition confirmed that while most macroeconomic variables are predominantly driven by their own past innovations, exchange rate shocks account for approximately 6.8% of inflation variance and up to 5.5% of fiscal deficit variance in the medium term. These findings underscore the centrality of exchange rate stability to Kenya's macroeconomic framework and call for coordinated fiscal-monetary policy responses, integration of exchange rate signals into inflation-targeting frameworks, and alignment of macro policy with the objectives of Kenya Vision 2030.

Suggested Citation

  • Nyekwel, Philip & Chesang, Laban & Musau, John & Kithandi, Charles Katua, 2026. "Exchange Rate Fluctuations and Macroeconomic Stability in Kenya: A SVAR Model," African Multidisciplinary Scholarship Journal, African Multidisciplinary Scholarship Journal, vol. 1(1).
    • Handle: RePEc:cwk:amsjke:2026-02
    DOI: 10.59413/amsj/v1.i1.2
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    References listed on IDEAS

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    1. Rana Shahid Imdad Akash & Muhammad Mudasar Ghafoor & Navid Ahmed, 2020. "Testing the Validity of Purchasing Power Parity Theory and Dynamics of Exchange Rate Behavior (Pakistan, China, Iran and Turkey)," Journal of Accounting and Finance in Emerging Economies, CSRC Publishing, Center for Sustainability Research and Consultancy Pakistan, vol. 6(1), pages 127-144, March.
    2. Kenneth Rogoff, 1996. "The Purchasing Power Parity Puzzle," Journal of Economic Literature, American Economic Association, vol. 34(2), pages 647-668, June.
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    4. Dario Caldara & Sarah Conlisk & Matteo Iacoviello & Maddie Penn, 2022. "The Effect of the War in Ukraine on Global Activity and Inflation," FEDS Notes 2022-05-27-2, Board of Governors of the Federal Reserve System (U.S.).
    5. Alan M. Taylor & Mark P. Taylor, 2004. "The Purchasing Power Parity Debate," Journal of Economic Perspectives, American Economic Association, vol. 18(4), pages 135-158, Fall.
    6. Guzman, Martin & Ocampo, Jose Antonio & Stiglitz, Joseph E., 2018. "Real exchange rate policies for economic development," World Development, Elsevier, vol. 110(C), pages 51-62.
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    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory

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