Determinants of Equilibrium Real Exchange Rate and its Misalignment in Kenya: A Behavioral Equilibrium Exchange Rate Approach

This paper examines the real exchange rate misalignment in Kenya using quarterly data over the period 2000 – 2014. The Behavioral Equilibrium Exchange Rate (BEER) approach to determine the extent of exchange rate misalignment is adopted. A vector error correction model (VECM) is estimated and the results show that the real exchange rate is largely driven by fundamentals. Thus, the equilibrium real exchange rate has been closely aligned to its long run equilibrium level, save for instances when misalignment occurred due to major economic shock such as the recent global financial crisis and the Euro zone economic crisis. Hence, given the managed float regime in Kenya, exchange rates keep adjusting to changing economic fundamentals.