DETERMINANTS OF REAL EXCHANGE RATE IN ETHIOPIA
DOI:
https://doi.org/10.29121/granthaalayah.v4.i6.2016.2652Keywords:
Exchange Rate, Ethiopian, Cointegration, Vector AutoregressionAbstract [English]
Real exchange rate has direct effects on trade particularly on international trade and has indirect effects on productions and employments, so it is crucial to understand the factors which determine its variations. This study analyses the main determinants of the real exchange rate and the dynamic adjustment of the real exchange rate following shocks to those determinants using yearly Ethiopian time series data covering the period 1971 to 2010. It begins with a review of literatures on Exchange rate, real exchange rate, determinants of the real exchange rate and provides an updated background on the exchange rate system in Ethiopia. An empirical model linking the real exchange rate to its theoretical determinants is then specified. This study had employed the cointegration and vector autoregression (VAR) analysis with impulse response and variance decomposition analyses to provide robust long run effects and short run dynamic effects on the real exchange rate.
Share of investment, foreign exchange reserve, capital inflow and government consumption of non-tradable goods were the variable that have been found to have a long run relationship with the real exchange rate. The estimate of the speed of adjustment coefficient found in this study indicates that about a third of the variation in the real exchange rate from its equilibrium level is corrected within a year.
The regression result of VECM reveals that terms of trade, nominal exchange rate, and one period lag of capital flow were the variables significantly affects the real exchange rate in the short run. However, the impulse response and variance decomposition analysis shows a better picture of the short run dynamics. The their analysis provided evidence that the Shocks to terms of trade, nominal exchange rate, capital inflow and share of investment have persistent effects on the real exchange rate in the short run. In general the regression results of both long run and short run models mostly suggest that the fluctuations of real exchange rates are predominantly responses to monetary policies shocks rather than fiscal policy shocks.
Downloads
References
Aron, et al, (1997), “Determinants of the Real Exchange Rate in South Africa”, Centre for the Study of African Economies,WPS/97-16, CSAEPublishing, and Oxford.
Baffes, et al, (1999), “Single- Equation Estimation of the Equilibrium Real Exchange Rate”, in Hinkle. DOI: https://doi.org/10.1596/1813-9450-1800
Beatrice KalindaMkenda (2001), “Long-run and Short-run Determinants of the Real Exchange Rate in Zambia.” Research paper 2001/40.
Black, Stanley, W., (1994), “On the Concept and Usefulness of the Equilibrium Rate of Exchange”, in Williamson, John (ed.), Washington DC.
Copeland, L. S., (1994). “Exchange rates and international finance.” Workingham, England: Addison-Wesley.
Degefa D. (2001), “The Parallel Foreign Exchange Market and Macroeconomic Performance in Ethiopia.”AERC Research Paper 107.
Edwards, S. (1989), Real Exchange Rates, Devaluation and Adjustment: Exchange Rate Policy in Developing Countries, MIT Press, Cambridge, Massachusetts
Elbadawi, I., (1994). “Estimating long-run equilibrium exchange rates.”Washington: Institute for International Economics.
Fosu, K.Y (1992). “The Real Exchange Rate and Ghana’s Agricultural Exports”, AERC Research paper, no.9 October 1992.
Geda, A. (2006), “The Structure and Performance of Ethiopia’s Financial Sector in the Pre- and Post-Reform Period with a Special Focus on Banking.” WIDER Research Paper 2006/112.
Giancarlo Gandolfo (2002),”International financial and Open Economy macroeconomics.” Springer printing press: Heidelberg. DOI: https://doi.org/10.1007/978-3-642-59508-0_14
Gujarati, D. N., (2003), “Basic econometrics”, fourth edition New York: McGraw-Hill Inc.
Harris R. (1995), Using Cointegration Analysis in Econometric Modeling. Printce hall.
Harry A. Sackey (2001). “External aid inflows and the real exchange rate in Ghana.”AERC Research Paper 110,Nairobi.
Jerome L. Stein, Polly Reynolds Allen, and Associates (1995). “Fundamental Determinants of Exchange Rates.” Clarendon Press, Oxford
John E. Floyd (2010). “Interest Rates, Exchange Rates and World Monetary Policy”, Springer, Toronto. DOI: https://doi.org/10.1007/978-3-642-10280-6
Kombe Oswald Mungule (2004), “The determinants of the real exchange rate in Zambia”. AERC, Research Paper 146.
Luintel, K. B. and khan, M., 1999, “A quantitative reassessment of the finance–growth nexus: evidence from a multivariate VAR.” Journal of Development Economics 60. DOI: https://doi.org/10.1016/S0304-3878(99)00045-0
Lütkepohl, H., 1991,”Introduction to multiple time series analysis”. New York: Springer-Verlag. DOI: https://doi.org/10.1007/978-3-662-02691-5
Miyakoshi, T., (2003). “Real exchange rate determination: empirical observations from East-Asian countries.”Empirical Economics28: 173-180.
Montiel, P. J. (1999). “Determinants of the long-run equilibrium real exchange rate.” New York: Oxford University Press.
Montiel, P. J., (2003). ”Macroeconomics in emerging markets.” Cambridge: Cambridge University Press. DOI: https://doi.org/10.1017/CBO9780511615870
Muhammad Zakaria and Ahmed Bilal Ghauri (2011). “Trade Openness and RealExchange Rate: Some Evidence from Pakistan.”Institute of Development Economics, Islamabad.
OpokuAfari, M. (2004), “Measuring the Real Effective Exchange Rate in Ghana.” CREDIT Research Paper 04/11.
Pedro M. G. Martins (2009), “Do Capital Inflows Hinder Competitiveness?” CREDIT Research Paper 10 (07).
Peter Takaendesa (2006), “The Behavior and Fundamental Determinants of the Real Exchange Rate in South Africa.”Rhodes University.
Pierre-Richard Agenor and Peter J. Montiel (2008). “Development Macroeconomics.“ 3rd Ed, Princeton University Press, Woodstock.
Rehana. S, Usman. A, and Zafar. M (1996), “Exchange Rate Determination in Pakistan.”The Pakistan Development Review, 35(4),683-692.
Robert DaudaKorsu and Samuel JamiruBraima (2007). “the determinants of the real exchange rate in Sierra Leone.” Fourah Bay College, University of Sierra Leone.
Ronald MacDonald (2007). “Exchange Rate Economics Theories and evidence”, Rutledge printing press, New York. DOI: https://doi.org/10.4324/9780203380185
Stefan Dercon and LulsegedAyalew (1994), Coffee Prices and Smuggling in Ethiopia, Ethiopian Journal of Economics, Vol. 3, No.2.
Downloads
Published
How to Cite
Issue
Section
License
With the licence CC-BY, authors retain the copyright, allowing anyone to download, reuse, re-print, modify, distribute, and/or copy their contribution. The work must be properly attributed to its author.
It is not necessary to ask for further permission from the author or journal board.
This journal provides immediate open access to its content on the principle that making research freely available to the public supports a greater global exchange of knowledge.
