The Relationship Between Selected Macroeconomics Variables and Foreign Exchange Rate in Kenya

Abstract

Volatility of foreign exchange rate (FX) is unsolved gap in research, FX and other macroeconomic variables have significant influence on the Kenyan economic growth. The study sought to determine the association between selected macro-economic variables and FX in Kenya. Among key theories reviewed in this study included Interest Rate Parity, Purchasing Power Parity and Ricardian theories. This paper adopted use of a correlational research design and collected secondary data based on quarterly data for sixteen years between 2006 and 2021. Data was collected from the World Bank Development indicators and the Central Bank of Kenya. The study used both descriptive and inferential statistical analysis. Dialogistic tests of normality, heteroscedasticity, multicollinearity and serial correlation were done. The outcomes depict a negative effect of interest rate on FX. Further, inflation rate had a positive but insignificant effect while GDP growth rate had a negative insignificant effect on FX. Money supply on the other hand had a positive effect on FX. The study concluded that interest rate has a negative effect on FX in Kenya. It also concluded that money supply has a positive effect on FX in Kenya. Inflation rate and GDP growth rate have no substantial effect on FX in Kenya. The recommendations include the development of policies by the state that would increase the lending rate; increase the GDP growth rate optimally; and reduce money supply within the country hence reducing the rate at which the Kenya Shilling exchanges with USD. The government policies that would increase lending rate in Kenya, would lead to decreased FX of KSh to USD. The government should also come up with policies that would increase GDP growth rate optimally; and reduce money supply within the country hence reducing rate at which Kenya Shilling exchanges with USD. From the research, future studies could be done on different timespans; and other macroeconomic variables influencing Kenyan FX against USD and different measures of FX.