4.6. Results and discussion 102
4.6.7. Structural VAR estimation results for Egypt 160
4.6.7.2. Variance decomposition analysis on Egypt 169
beginning and later falls resulting in inverse behaviour from the manufacturing output growth; that is it falls briefly and rises sharply later in response to the currency depreciation. The inflation that occurs here appears to be a monetary phenomenon as it follows the pattern of response of money supply to the exchange rate shock. When the money supply rises, inflation also rises and when money supply begins to fall inflation also starts falling.
4.6.7.2 Variance decomposition analysis on Egypt
Table 4.28: Variance decomposition of money supply growth rate (Egypt)
Period Oil price
output Oil
growth Interest rate
Money supply
growth Inflation
rate Exchange
rate Manufacturing
growth GDP
growth
3 2.882352 0.002558 0.123209 53.00414 1.217218 38.90868 0.061724 3.800115
6 4.058707 0.204024 0.229515 57.18929 1.757792 23.99649 0.238932 12.32525
9 3.426626 0.779179 0.089283 60.43908 1.646193 14.40817 1.878193 17.33329
12 1.834615 1.106545 0.096916 43.98007 1.062448 34.42860 3.035066 14.45575
The dominance of the exchange rate in the monetary policy transmission mechanism in Egypt is also observed with the large influence it has on the money supply growth rate.
Table 4.28 again shows that the exchange rate shock contributes the highest percentage to the fluctuations of money supply growth rate in Egypt. This means that the pattern of behaviour exhibited by the money supply is mostly determined by the exchange rate. It should be noted here that the price of oil plays an important role in determining the money supply growth, but not as high as the exchange rate.
The effect of the oil price shock on the money supply as a monetary policy instrument is more pronounced than that of the interest rate. Inflation rate shock also contribute large shock to the money supply behaviour. This is an indication that the effect of the oil price on output of the manufacturing sector is likely to pass through the exchange rate and inflation rate. In addition, in line with our previous findings, the oil price shock contributes more than the oil output growth shock to fluctuations in money supply.
The result also shows that there is a strong linkage between money supply and GDP growth rate. It indicates that GDP fluctuations can have a very strong effect on the money supply growth rate in Egypt.
Table 4.29: Variance decomposition of inflation rate (Egypt)
Period Oil price
output Oil
growth Interest rate
Money supply
growth Inflation
rate Exchange
rate Manufacturing
growth GDP
growth
3 0.026666 0.016867 0.308461 0.947655 76.87957 18.77488 2.348216 0.697681
6 1.396478 1.121560 1.106616 1.148199 59.90568 25.73016 9.127256 0.464052
9 1.217637 1.492078 0.440852 4.027084 20.18283 69.01982 2.902696 0.716999
12 0.473962 1.286042 0.177336 6.058079 6.045270 81.13250 1.876648 2.950168
Table 4.29 shows that the inflation pattern in Egypt is mostly dictated by the exchange rate shock. The exchange rate shock accounts for the largest proportion of the fluctuations in inflation rates in Egypt. Money supply is another variable in the monetary policy transmission mechanism that plays a very important role in determining the level of inflation in Egypt. This affirms that inflation in Egypt is likely to be a monetary phenomenon. A strong linkage is also established between fluctuations in manufacturing output growth and inflation rate.
The conclusion from the table is that the inflation rate in Egypt is mostly driven by shocks from the exchange rate and money supply growth rate. Unlike other countries studied in the previous sections, the dominance of the interest rate in determining inflation rates is weak in Egypt.
Table 4.30: Variance decomposition of exchange rate (Egypt)
Period Oil price
output Oil
growth Interest rate
Money supply
growth Inflation
rate Exchange
rate Manufacturing
growth GDP
growth
3 0.707791 0.778798 0.077022 0.027127 0.798941 96.62677 0.976718 0.006834
6 0.715545 0.784927 0.132836 0.020220 0.817789 96.51526 0.990439 0.022986
9 0.713860 0.793649 0.154404 0.014230 0.830373 96.44662 1.005692 0.041175
12 0.707037 0.801226 0.160558 0.009597 0.836684 96.40000 1.025730 0.059164
Oil price, oil output growth rate, as well as manufacturing output growth account for a relatively large proportion of the variations in exchange rates in Egypt. As indicated previously in our explanation, the Egyptian economy has a very strong non-oil sector which generates substantial export earnings. Again, oil output is also traded in foreign currency which explains the strong linkages with the exchange rate. This is shown in Table 4.30 where oil output and oil price shocks make the highest contribution to fluctuations in the exchange rate. Output from the manufacturing sector is also an important shock influencing the behaviour of the exchange rates in Egypt.
After, these two shocks, inflation rate shocks also appear to be another strong determinant of exchange rates in Egypt. It should be noted that the two monetary policy instruments do not have a significant influence on the behaviour of exchange rates in Egypt.
Table 4.31: Variance decomposition of manufacturing growth (Egypt)
Period Oil price
output Oil
growth Interest rate
Money supply
growth Inflation
rate Exchange
rate Manufacturing
growth GDP
growth
3 0.405075 0.266771 0.805301 0.235182 0.132586 77.95759 19.05568 1.141806
6 0.798552 0.394174 0.505786 0.319176 0.466422 90.63480 6.189068 0.692018
9 1.063597 0.376468 0.413912 0.985100 0.721682 91.65815 4.290301 0.490791
12 1.274926 0.359240 0.391845 2.846497 0.913037 89.24534 4.037134 0.931984
Following the results obtained in the analysis of impulse response functions, manufacturing output growth rate is mostly influenced by the exchange rate shock. The results in Table 4.31 corroborate what has been observed so far about the dominance of the exchange rate in the monetary policy transmission mechanism and its effect on the manufacturing output in Egypt. The exchange rate shock appears to have overshadowed the contribution of all other shocks to manufacturing output fluctuations, making the behaviour of the manufacturing sector highly subject to the exchange rate shock.
The oil price shock also affects the manufacturing sector but the influence goes through the exchange rate which also confirms what has been observed in the previous analyses.
A very important conclusion that can be drawn from the variance decomposition analysis on Egypt is the finding that the exchange rate is the most important factor that influences the structure of the monetary policy transmission mechanism in the country.
In addition, this is the factor that influences the behaviour of the manufacturing sector the most.