Global Financial Tightening Conditions and Foreign Exchange Volatility in Kenya
Keywords:
Foreign exchange volatility, global financial tightening, EGARCH, stochastic volatility, Kenya Shilling, monetary policy, Federal Reserve, exchange rate management
Abstract
Emerging-market economies like Kenya are experiencing heightened foreign-exchange (FX) volatility due to ongoing global financial-tightening measures that integrate them into a dysfunctional global economic system yet theoretical models diverge on transmission mechanisms. The Conventional Mundell-Fleming model views flexible rates as shock absorbers, while post-Keynesian-structuralist theory warns of endogenous amplification via balance-sheet fragilities. This study tests these competing frameworks using DCC-GARCH on monthly data (Jan 2004- June 2025) for Kenya's shilling, modeling interactions between US Fed rates (FED), global liquidity (GLI), CBK policy rate (CBR), Foreign exchange reserves, remittances, and global risk factors. Results confirm strong persistence in FX volatility driven by FED tightening and global risk, with significant DCC correlations rejecting transitory absorption. Domestic Monetary policy proxied by Central Bank Rate (CBR) exhibits weak shock response despite high persistence, while FED/CBR and GLI/CBR interactions show procyclical leverage effects validating Köhler's Minskyan cycles over symmetric Mundell-Fleming adjustment. These findings advance the emerging market theoretisation by demonstrating how global financial tightening triggers contractionary balance-sheet channels in debt-dependent economies, limiting domestic monetary policy autonomy. Kenya should prioritize macroprudential buffers alongside reserves accumulation over sole rate reliance to mitigate future US-led volatility spillovers.
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References
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29. Gachara, P. M. (2015). Transmission Channels of Crude Oil Price Shocks on Kenya’s Economy (Doctoral dissertation, Kenyatta University).
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36. Iacoviello, M., & Navarro, G. (2019). Foreign effects of higher US interest rates. Journal of International Money and Finance, 95, 232-250.
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43. MASEconomics.. (2025) Mundell-Fleming model for open economies. https://maseconomics.com/mundell-fleming-model-for-open-economies/
44. Matschke, J., von Ende-Becker, A., & Sattiraju, S. A. (2023). Capital Flows and Monetary Policy in Emerging Markets around Fed Tightening Cycles. Economic Review (01612387), 108(4).
45. Mbugua, M., & Maseno, A. (2024, March 6). The impact of the fluctuation of the Kenyan currency with regards to investment in Kenya. Retrieved September 12, 2025, from https://www.cliffedekkerhofmeyr.com/news/publications/2024/Practice/Corporate/corporate-and-commercial-alert-6-march-the-impact-of-the-fluctuation-of-the-kenyan-currency-with-regards-to-investment-in-kenya#:~:text=investment%20in%20Kenya-,The%20impact%20o
46. Miriti, G. K. (2024). Effects of exchange rate volatility on Kenya-China bilateral trade (Doctoral dissertation, Strathmore University).
47. Mohanty, M. S. (2013). Market volatility and foreign exchange intervention in EMEs: What has changed?-an overview. An Overview (October 2013). BIS Paper, (73a).
48. Monday, T.E. & Abdulkadir, A., 2020. Modeling Fluctuation of the Price of Crude Oil in Nigeria Using ARCH, ARCH-M Models. Asian Journal of Probability and Statistics, pp.16–40. Available at: https://doi.org/10.9734/ajpas/2020/v7i130171.
49. Mosbei, T., Samoei, S. K., Tison, C. C., & Kipchoge, E. K. (2021). Exchange rate volatility and its effect on intra-East Africa Community regional trade. Latin American Journal of Trade Policy, 4(9), 43-53.
50. Mwangi, S. C. (2015). An Evaluation of Effects of Exchange Rate Volatility on Kenya’s French Bean Exports (Doctoral dissertation, University of Nairobi). Retrieved on September 23, 2025 from http://repository.embuni.ac.ke/handle/123456789/647
51. Mukherjee, P. & Bardhan, S., 2024. Dynamic Spillovers Among Equity, Gold and Oil Markets During COVID and Russia-Ukraine War: Evidence from India. Asia-Pacific Financial Markets. Available at: https://doi.org/10.1007/s10690-024-09482-7.
52. Mundell, R. A. (1960). The monetary dynamics of international adjustment under fixed and flexible exchange rates. The Quarterly Journal of Economics, 74(2), 227-257.
53. Ndagara, M. M., Mugendi, L. K., & Galo, N. M. (2020). Effectiveness of Monetary Policy intervention on Exchange Rate Volatility in Kenya. Journal of Environmental Sustainability Advancement Research Vol. 6 .
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Published
2026-02-20
How to Cite
Lidiema, C., & Adhikary, T. C. (2026). Global Financial Tightening Conditions and Foreign Exchange Volatility in Kenya. European Scientific Journal, ESJ, 50, 441. Retrieved from https://eujournal.org/index.php/esj/article/view/20661
Section
ESI Preprints
Copyright (c) 2026 Caspah Lidiema, Twisha Chakraborty Adhikary
This work is licensed under a Creative Commons Attribution 4.0 International License.
