Munich Personal RePEc Archive

Real interest rate differentials and the real exchange rate: Evidence from four African countries

Reinhart, Carmen and Asea, Patrick (1995): Real interest rate differentials and the real exchange rate: Evidence from four African countries.

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Abstract

During the early 1990s much has been written about the return of foreign private capital to many of the larger Asian and Latin American countries. However, until 1992 there was little evidence that countries in sub-Saharan Africa were participating in this phenomenon. In this paper we use variance decompositions and impulse responses from vector autoregressions to shed light on the possible causes and consequences of capital inflows to four countries: Ghana, Kenya, Uganda, and Zimbabwe. We use trend-cycle decompositions to provide evidence linking the appreciation of the real exchange rate to periods of heavy capital inflows. We show that domestic real interest rates have played an important role in explaining the recent behavior of the real exchange rate. In particular, we trace the rise in domestic nominal and real interest rates to policies designed to liberalize the domestic financial sector and attempts to curb the monetary expansion associated with the capital inflows through sterilized intervention.

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