Testing New Measures of Exchange Market Pressure in Sub-Saharan Africa

Attempts by economists to identify exchange rate crisis have led to the development of the exchange market pressure (EMP) index, which has been modified to include the interest rate variable, to better capture pressure on domestic currencies. The index in this state (current) is more appropriate for countries who operate an inflation targeting (IT) monetary policy framework or a policy framework close to it. This observation among others makes the EMP index sensitive to some assumptions if sub-Saharan African countries (SSA) are involved. SSA countries employ different monetary policy frameworks making the usage of the EMP index across board misleading. Using different variations of the model specified by authors specialised in the subject, this study identified an EMP index which will be effective in identifying currency crisis in 32 sub-Saharan African (SSA) countries for which data is available. Using a ridge regression model and a dynamic OLS model as a control, the study showed that the original EMP index was good in explaining changes in the exchange rate variable in SSA if the changes in reserves are adjusted for by broad money. The explanatory power is further enhanced if the components are normalised by their standard deviations without adjusting for the money variable. It was discovered that the current version of the index which includes the interest rate variable is not good at explaining changes in the exchange rate variable in SSA even though it had some explanatory effect.