Dr. Mustafa Kasim, Academic Team Lead & MA Dissertation Lead, FSB Digbeth. Photo: FSB

By Dr. Mustafa Kasim, Academic Team Lead & MA Dissertation Lead, FSB Digbeth

Independence of Central Bank of Egypt and Exchange Rate Regimes

In today’s global economy, the interaction between national economic policies and international market forces is crucial. This article explores how Egypt’s central bank navigates these challenges to maintain economic stability and policy independence.

Key Insights and Findings

Macroeconomic Independence: Different exchange rate regimes impact Egypt’s macroeconomic independence, especially in relation to the European Union (EU) and the United States (US). Using the Auto-Regressive Distributed Lag (ARDL) model, our research shows that Egypt’s market for goods and monetary policy demonstrate long-term independence from these major economies. This indicates that the Central Bank of Egypt (CBE) can set its policy direction without external economic shocks influencing its decisions (Edwards, 2015).

Exchange Rate Regimes: Egypt has moved from a fixed exchange rate system to a more flexible one over the years. This shift has significant implications for the country’s economic policy. We examined different periods, including the pegged regime (1980-1990), managed floating regime (1991-2004), and inflation targeting policy (2005-2016). Despite the move towards flexibility, the CBE has successfully maintained its policy independence, which is crucial for achieving domestic economic goals. Interestingly, during the pegged exchange rate period, there was no correlation between Egypt’s consumer price index (CPI) and interest rates with those of the EU and US, which contradicts common theoretical expectations.

Cover page of the Handbook of Banking and Finance in the MENA Region.

Methodological Approach: To analyse these dynamics, we used the ARDL model, also known as the Bounds Test. This robust methodology allowed us to examine the long-term relationships between Egypt’s domestic variables and those of the EU and US. We tested hypotheses regarding the independence of Egypt’s CPI and short-term interest rates. This methodology is particularly beneficial as it accommodates variables with mixed levels of integration, ensuring a comprehensive analysis (Nkoro et al., 2016).

Empirical Evidence and Theoretical Implications: Our findings provide support for the theories of Purchasing Power Parity (PPP) and Uncovered Interest Parity (UIP). Contrary to the belief that flexible exchange rates enhance monetary policy autonomy, our research shows that even under a pegged regime, Egypt managed to sustain a degree of independence in both its goods market and monetary policy. This challenges the idea that small open economies lose their policy autonomy under fixed exchange rate systems. Specifically, we found no significant long-term relationship between Egypt’s and the EU’s or US’s CPI and interest rates during the pegged and managed floating exchange rate periods (Selim, 2012; Massoud and Willett, 2014).

Conclusion

This research contributes significantly to understanding how emerging economies like Egypt navigate the global financial system. By maintaining macroeconomic independence through various exchange rate regimes, we provide valuable insights for policymakers and economists. The experience of the Central Bank of Egypt offers lessons on achieving economic stability amidst global interdependencies.

Interestingly, we also address the “fear of floating” phenomenon, where central banks might still intervene to stabilise the currency despite officially adopting a floating exchange rate. This nuanced understanding is crucial for appreciating the complexities faced by developing nations in their monetary policy decisions.

For an in-depth exploration of our methodologies, empirical findings, and the theoretical implications of our study, we encourage you to read the complete chapter. The chapter is accessible at https://doi.org/10.1142/9781800614734_0009. This work has been published in the “Handbook of Banking and Finance in the MENA Region” by World Scientific Publishing, a distinguished and highly regarded publisher in the academic community.

References

Edwards, S. J. T. W. E., (2015). Monetary policy independence under flexible exchange rates: an illusion?. Economic Inquiry, 38(5), pp. 773-787.

Massoud, A. A. & Willett, T. D., (2014). Egypt’s Exchange Rate Regime Policy after the Float. International Journal of Economics and Finance, 2(1).

Nkoro, E. and Uko, A.K., (2016). Autoregressive Distributed Lag (ARDL) cointegration technique: application and interpretation. Journal of Statistical and Econometric Methods, 5(4), pp. 63-91.

Massoud, A. A. & Willett, T. D., (2014). Egypt’s Exchange Rate Regime Policy after the Float. International Journal of Economics and Finance, 2(1).

Selim, H., (2012). Exploring the role of the exchange rate in monetary policy in Egypt. A paper presented at the ERF 18th Annual Conference, March.