The Effect of Selected Macro-economic Variables on Exchange Rates in Kenya

Abstract

This study aimed at determination of the effect of selected macro-economic variables on exchange rates in Kenya. A rate of exchange is the rate at which one currency is exchanged for another for trading purposes. It is used for the determination of how much of a currency can be used to purchase goods and services in a country. The dependent variable in this study was Exchange rates (KSH/USD) while independent variables were inflation as determined by the consumer price index, interest rates and aggregation of trade flows as measured by balance of payments divided by GDP. The study period was for ten years from January 2006 to December 2015 using secondary data on inflation, interest rates and aggregation of trade flows as well as the spot rate for exchange rate over that period with data being collected monthly. The study employed a descriptive research design and a multiple linear regression model was used to analyze the relationship between the variables. Statistical package for social sciences version 21 was used for data analysis purposes. Results of the study showed that interest rate had a positive correlation coefficient of 0.446 with exchange rate, Inflation rate and exchange rate had a correlation coefficient of negative 0.395 while the Level of aggregation of trade flows had a correlation coefficient of positive 0.829 to the exchange rate. The value of R square was 0.745, a discovery that 74.5 percent of the deviations in exchange rates in Kenya occurred due to changes in interest rate, inflation rate and trade flows at 95 percent confidence level. Other variables not included in the model justify for 25.5 percent of the variations in exchange rates in Kenya. Also, the results revealed that there exist a strong relationship among the selected macro-economic variables and exchange rate as shown by the correlation coefficient (R) equal to 0.863.The significance value obtained was 0.00 which was less than p=0.05 implying that the model was statistically significant in predicting how the macro economic variables of interest rate, inflation rate and trade flows affect exchange rates in Kenya. The study suggested that similar studies should be undertaken covering a longer period of study years and also taking into account other macro-economic variables not considered in this study.