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, such as Kenya, are experiencing heightened foreign exchange (FX) volatility because of ongoing global financial-tightening measures that integrate them into a dysfunctional global economic system. In contrast, theoretical models, such as the Conventional Mundell–Fleming model and post-Keynesian–structuralist theory, diverge on the transmission mechanisms. Therefore, this study tests these competing frameworks to examine the impact of U.S. Federal Reserve (FED) rates, global liquidity (GLI), and global risk factors on Kenya shilling volatility. This study employed a two-stage multivariate volatility dynamic conditional correlation exponential GARCH (DCC-EGARCH) model to measure the impact of financial tightening on Kenya’s Forex volatility from January 2004 to June 2025. The 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 the central bank rate (CBR), exhibits a weak shock response despite high persistence, whereas Fed/CBR and GLI/CBR interactions show procyclical leverage effects, validating Köhler's Minskyan cycles over symmetric Mundell-Fleming adjustments. These findings advance emerging market theoretisation by demonstrating how global financial tightening triggers contractionary balance-sheet channels in debt-dependent economies, thereby limiting domestic monetary policy autonomy. Kenya should prioritize macroprudential buffers alongside reserves accumulation over sole rate reliance to mitigate future US-led volatility spillovers. The originality of this paper lies in the testing of the Conventional Mundell-Fleming model, which views flexible rates as shock absorbers, versus the post-Keynesian-structuralist theory, which warns of endogenous amplification via balance-sheet fragilities.
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References
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12. Baek, J., & Kim, H. Y. (2020). On the relation between crude oil prices and exchange rates in sub-saharan African countries: A nonlinear ARDL approach. The Journal of International Trade & Economic Development, 29(1), 119-130.
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20. Daggash, J., & Abraham, T. W. (2017). Effect of Exchange Rate Returns on Equity Prices: Evidence from South Africa and Nigeria. International Journal of Economics and Finance, 9(11), 35. https://doi.org/10.5539/ijef.v9n11p35
21. Dua, P., & Verma, N. (2024). Dynamics of Capital Flows and Global Factors: Case of Emerging Economies.Journal of Quantitative Economics, 22(4), 945-975. http://doi.org/10.1007/s40953-024-00409-7
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23. Engle, R. F. (2002). Dynamic conditional correlation: A simple class of multivariate generalized autoregressive conditional heteroskedasticity models. Journal of Business & Economic Statistics, 20(3), 339–350. https://doi.org/10.1198/073500102288618487
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25. Engler, P., Piazza, M. R., & Sher, G. (2023). Spillovers to emerging markets from US economic news and monetary policy. International Monetary Fund.
26. Filardo, A., Gelos, M. R., & McGregor, T. (2022). Exchange-rate swings and foreign currency intervention. International Monetary Fund.
27. Fleming, J. M. (1962). Domestic Financial Policies under Fixed and under Floating Exchange Rates. Staff Papers-International Monetary Fund, 369-380.
28. Fratzscher, M., Gloede, O., Menkhoff, L., Sarno, L., & Stöhr, T. (2019). When is foreign exchange intervention effective? Evidence from 33 countries. American Economic Journal: Macroeconomics, 11(1), 132-156.
29. Gachara, P. M. (2015). Transmission Channels of Crude Oil Price Shocks on Kenya’s Economy (Doctoral dissertation, Kenyatta University).
30. Habib, M. M., & Venditti, F. (2018). The global financial cycle: implications for the global economy and the euro area. Economic Bulletin Articles, 6.
31. Hanusch, M., Nguyen, H., & Algu, Y. (2018). Exchange rate volatility and FDI inflows: Evidence from cross-country panel data.
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https://www.centralbank.go.ke/images/docs/Research/Exchange_Rate_Response_to_Policy_News_in_Kenya.pdf
37. Kearns, J., & Manners, P. (2018). The impact of monetary policy on the exchange rate: A study using intraday data. Seventh issue (December 2006) of the International Journal of Central Banking.
38. Kiptui,M. (2019). An Assessment of Exchange Rate Misalignment in Kenya. Central Bank of Kenya (CBK). Retrieved on June 17, 2025 from https://www.centralbank.go.ke/uploads/working_papers/668977093_Kenya%20Exchange%20Rate%20Misalignment%20Version%20final%20-%20December%202019.pdf
39. Le, C., Nguyen, H., & Vo, D. (2024). Global liquidity spillovers in the Asia–Pacific region: policy-driven versus market-driven effects. Empirical Economics,67(3), 1091-1113. http://doi.org/10.1007/s00181-024-02573-4
40. Maana, I., Mwita, P.N., & Odhiambo, R. (2010). Modelling the volatility of exchange rates in the Kenyan market. Journal of Business Management . Vol. 4(7), pp. 1401-1408, 4 July, 2010 Available online at http://www.academicjournals.org/AJBM
41. MASEconomics.. (2025) Mundell-Fleming model for open economies. https://maseconomics.com/mundell-fleming-model-for-open-economies/
42. 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).
43. 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
44. Miriti, G. K. (2024). Effects of exchange rate volatility on Kenya-China bilateral trade (Doctoral dissertation, Strathmore University).
45. Mishra, P., Moriyama, K., N'Diaye, P., & Nguyen, L. (2014). Impact of Fed tapering announcements on emerging markets (IMF Working Paper No. 14/109). International Monetary Fund. https://doi.org/10.5089/9781498313933.001
46. 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.
47. 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.
48. 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
49. 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.
50. 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.
51. Ncube, M., & Ndou, E. (2013). Monetary policy, fiscal policy and the exchange rate channel in South Africa and other emerging markets. African Development Bank Group Working Paper Series No. 189.
52. 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
2026-03-31
How to Cite
Lidiema, C., & Chakraborty, T. A. (2026). Global Financial Tightening Conditions and Foreign Exchange Volatility in Kenya. European Scientific Journal, ESJ, 22(7), 73. https://doi.org/10.19044/esj.2026.v22n7p73
Section
ESJ Social Sciences
Copyright (c) 2026 Caspah Lidiema, Twisha Adhikary Chakraborty
This work is licensed under a Creative Commons Attribution 4.0 International License.
