Inflation and Exchange Rate Variability in East Africa: A Panel Regression Analysis

Abstract

The East African Community states established targets for macroeconomic convergence, with an aim to eliminate exchange rate variability within the bloc so as to establish a monetary union by 2024. The purpose of the paper was to assess the impact of inflation convergence on exchange rate variability in the East African Community Member States from 1995 to 2019. Therefore, panel data on official exchange rates as a dependent variable, annual inflation rate as an independent variable, GDP growth and total reserves as the control variables retrieved from the World Bank data base was used, this helped to calculate descriptive statistics and conduct a panel regression analysis while ensuring stationarity and absence of multicollinearity by using STATA. Also, the Hausman test was used to validate the use of the random effects model for the panel data. As a result, it was revealed that EAC member states exhibit inflation convergence and they are about to achieve the convergence criteria set, a low degree of exchange rate variability among the EAC member states, and inflation convergence had a weak negative relationship with exchange rate variability. The study recommended that EAC countries need to integrate the macroeconomic convergence bench marks into national planning and decision making, to create a political will and public awareness in forming a monetary union, and developing efficient monetary and fiscal policies that will harmonize the macroeconomic variables and reduce exchange rate variability