The effect of exchange rate policy on the economic development of Kenya

by Porter, Tom G.

This dissertation attempts to assess the negative effect that the Kenyan governmentfs exchange rate policy had on aggregate output and on sectoral composition of output. The Kenyan government chose a rnacroeconomic policy set in order to achieve certain economic, political, and social goals as part of its development objectives. The policy mix included industrialization policies, a expansionary monetary policy, a pegged exchange rate, and other policies that created a bias against the agricultural sectorç. An empirical rnacroeconomic mode1 was constructed to capture the economic processes that cause equilbirium exchange rate fluctuations. The exchange rate is determined by Kenya's price level relative to the rest of the world and by Kenya's productivity relative to the rest of the world. Exogenous events and government policies that affect the price level and productivity will influence the exchange rate as well. A mode1 of equilibrium exchange rate movements can then be used to asçess exchange rate misalignment : i .e., when the exchange rate undervalues or overvalues the domestic currency relative to foreign currency. Given a calibrated mode1 for Kenya's macroeconomy, a simulation was used to compare Kenyag s actual experience with a counter-factual exchange rate policy that produces no relative price distortions. The results indicate, among other effects, chat a floating exchangs rate policy would have Ied to policy that higher Kenya total output compared to the actually pursued. exchange rate iii The efforts 1 have made in completing the Agricultural Economics Ph.D. program are small compared to the support and advice that I have needed £rom my wife, Sarah. I have also received a wealth of advice and encouragement from my parents, brothers and sisters. 1 cannot püt into words how important my family is or how grateful 1 am for their love. 1 extend my most sincere thanks to Dr. Chris D. Gerrard for guiding the first two years of my research. The research would have been impossible without his efforts. Dr. Gerrardfs vision of a general equilibrium approach for studyingmacroeconomic policy effects on African agricultural development and his considerable capabilities were absolutely necessary for directing my naive struggles. I rust also thank Dr. Richard Manning, of the Economic Development Institute of the World Bank. Dr. Manning recognized the need for developing the mode1 for educational puvoses, and generously funded the research. The supervisors for the dissertation, Dr. Robert Lucas and Dr. Hartley Furtan, each provided theoretical anà practical direction for the research. Dr. Lucasr clear and intricate understanding of macroeconomic theory and macroeconomic modelling were indispensible for completing the dissertation. Dr. Furtan helped ground the mode1 with respect to Kenyafs agricultural development. He also pushed me to write the dissertation in such a manner that I understood what 1 was arguing arid that others could understand the argument as well, 1 thank Dr. Richard Gray because he was always available to offer advice and guidance for estimating and calibrating the model. Dr, Gray's amazing range of skills has taught me a great deal about econometrics and prior beliefs. 1 would also like to thank Dr. Terry Veeman, the External Examiner for my defense. Dr. Veeman's questions were en1 ightening and signif icantly improved the final draf t of my dissertation. The entire cornmittee helped improve the final version with their questions and comments during the de£ ense. The colleagues that 1 have worked with since the beginning of my Ph.D. studies greatly contributed to the experience. I know more about economics and distant parts of the world because of the conversations, classes, and other trials that we shared. The faculty of Agricultural Economics contributed to my education in many, and probably unknown, ways. I would like to particularly thank Dr. Jack Stabler for being available during the weeks leading to the defense, and Dr. Gary Storey for being available as a faculty member and as a friend. The final note cf thanks belongs to C. Arthur Battiste and Anne T. Ballantyne. Art and Anne have provided me with time, resources, and encouragement. Their professional and intellectual accomplishments inspire me. frieridship motivates me to excel. Having their To Sarah Thank pu, Sarah. There is no amount of knowledge that can compare to the love, support, and patience that you have provided. There is no howledge greater than the love of family.