Exchange rates and economic growth in Kenya : an econometric analysis

Based on data for the period 1970 to 1996, the study analyzes the possible direct and indirect relationship between the real and nominal exchange rates and GDP growth. These relationships are derived in three ways: within the context of a fully specified (but small) macroeconomic model; as a single-equation instrumental variable estimation; and as a vector-autoregression model. The estimation results from the three different settings show that there is no evidence of a strong direct relationship between changes in the exchange rate and GDP growth. Rather, Kenya"s rate of economic growth has been directly affected by fiscal and monetary policies, the availability of foreign aid, and other economic variables, particularly the growth of exports. Together, these factors have tended to sustain a pattern of real exchange rate over-valuation, which has been unfavorable for growth. The study concludes that improvements in exchange rate management alone are not adequate for the revival of growth in Kenya, but have to be part of a broader program of economic reform. (Author abstract)