Abstract: This paper investigates how interest rates are likely to have influenced the exchange rate movements in Kenya. It set to establish if interest rates have a significant contribution to the level of exchange rate or vice versa. It has also set out to determine if the International Fisher’s effect applies to Kenya with respect to the United States. Using a Vector Autoregressive model the paper estimated the relationship among the key variables i.e exchange rate and interest rates. The study made use of VAR regressions and multivariate Granger causality tests. From the VAR analysis using impulse responses, the research established that changes on the exchange rates are sensitive to all its past values upto the second lag but with varying degrees with the past one month value having the most significance. The change on exchange rate is also sensitive to the previous month’s change on the foreign interest rate. In addition the changes to the local interest rate are sensitive to the change in exchange rate in the third lag and also changes on its own lagged values in the second and third months respectively. In concluding the VAR estimate analysis, changes on the foreign interest rate are not sensitive to changes on any of the other variables including its own lagged values. The multivariate granger causality diagnosed that, changes on the local interest rate do not cause changes on the exchange rate while changes on the foreign interest rates do not cause changes in the exchange rate. In addition, changes on both the local and foreign interest rates jointly do not cause changes on the exchange rate. However, changes on exchange rate cause changes in the local interest rate while changes on the foreign interest rates do not cause changes in the local interest rate. In addition, changes on both the exchange rate and foreign interest rate jointly do cause changes on the local interest rate. Finally changes on exchange rates do not cause changes in the foreign interest rate while changes on the local interest rates do not cause changes in the foreign interest rate. Further, changes on both the exchange rate and local interest rate jointly do not cause changes on the foreign interest rate. In conclusion, the research also established that the International Fishers effect does not apply to Kenya with respect to the United State.
Keywords: Vector Auto regression, Exchange rate, Interest rate parity and Fischers Effect.
Title: Effects of Interest Rates on Foreign Exchange Rate in Kenya
Author: BERNARD KIPKEMOI, GEORGE KOSIMBEI
International Journal of Management and Commerce Innovations
ISSN 2348-7585 (Online)
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