The Impact of Real Exchange Rate Misalignment on Economic Growth; Kenyan Evidence

Abstract

This paper examines Real Exchange Rate (RER) Misalignment on economic growth in Kenya by using Johansen Cointegration, and Error Correction Model Technique to establish the factors that determine equilibrium real exchange rate, calculate the real exchange rate misalignment as the difference between equilibrium and actual real exchange rate. Generalized Method Moments (GMM) technique was used to assess the impact of the real exchange rate misalignment on economic growth for the period of January 1993 to December 2009. Data for the study was collected from Kenya National Bureau of Statistics, Central Bank of Kenya and International Monetary Fund Data Base by taking monthly frequency. Thus, 204 data values were analysed, which assisted in evaluating the extent of the trade Kenya had with different countries and used in the construction of the Real Exchange Rate (RER). The results of the study on the extent of RER misalignment suggest that over the study period 1993-2009, Kenya’s RER generally exhibited a depreciating trend, implying that in general, the country’s economic growth deteriorated over the study period. Keywords: Real Exchange Rate, Nominal Exchange Rate, Real Effective Exchange Rate, Nominal Effective Exchange Rate, Misalignment