Determinants of Nominal Effective Exchange Rate in Uganda (2000-2017): A Vecm Approach

Abstract

This study analyses the main determinants of the nominal effective exchange rate using quarterly time series data covering the period 2000 to 2017. The Augmented Dickey Fuller test confirms that all the with the exception of interest rate were non stationary in levels. This study employs the reduced form Vector Auto-regression (VAR) and Johansen and Juselius cointegration to estimate the long run relationship between exchange rate and other key variables. The VAR is used following the Mundell-Fleming model which argues that, in an open economy with external trade and financial transactions the key macro variables interact and influence each other with lags. The impulse response functions are used to investigate the monetary policy transmission mechanism (MPTM). The study indicates that money supply, terms of trade and inflation were negative while gross domestic product and interest rate were positively related to exchange rate . The variables were found to have a long run relationship.  The estimate of the speed of adjustment indicates that when nominal effective exchange rate deviates from the equilibrium, it returns to the equilibrium quickly because of its coefficient of adjustment which is 0.25.