The Monetary Approach to Exchange Rates in the East African Community

Abstract

This study investigates the monetary model of exchange rates determination using a panel framework for five East African countries—Kenya, Uganda, Tanzania, Rwanda, and Burundi—over the period 1995–2023. The analysis follows a systematic five-step methodology: cross-sectional dependence test, panel unit root test, panel cointegration analysis, estimation using the Pool Mean Group (PMG) method, and the Dumitrescu–Hurlin causality test. In the long run, our empirical results exhibit that, real GDP and real interest rates have a statistically significant negative impact on nominal exchange rates, while money supply exhibits a positive and significant effect. Causality analysis indicates unidirectional causality from real GDP and money supply to the nominal exchange rate, as well as from the exchange rate to the interest rate. Additionally, reverse causality exists between interest rates and money supply. No causal relationship is observed between real interest rates and real GDP or between real GDP and money supply. From a policy perspective, this study recommends a joint coordination of monetary policies amongst the East African Community member states in order to reduce exchange rate volatility, fostering regional economic stability and resilience.