TITLE:
The Role of Forecasting Exchange Rate Volatility and Its Impact on Inflation in Sierra Leone: Evidence from a GARCH-MIDAS approach
AUTHORS:
Edmund Chijeh Eric Tamuke, Lavinia Olayinka Madleine Kamara
KEYWORDS:
Exchange Rate Volatility, Inflation, GARCH-MIDAS-X, Machine Learning and Forecast Methods
JOURNAL NAME:
Open Access Library Journal,
Vol.11 No.9,
September
19,
2024
ABSTRACT: This research investigates the relationship between exchange rate volatility forecasting and its impact on inflation in Sierra Leone, utilizing a GARCH-MIDAS approach with mixed data. The analysis spans from January 2020 to August 2023 for monthly inflation and daily nominal exchange rates, employing the GARCH-MIDAS model and the Prophet machine learning model for forecasting exchange rates. Our findings highlight a robust link between monthly inflation and daily exchange rate volatility, emphasizing the critical connection between exchange rate depreciation and heightened inflation in Sierra Leone’s import-reliant economy. Exchange rate patterns reveal a consistent depreciation trend of the Leone against the US dollar, with a projected peak rate of 1 US dollar equal to 25.64 Leones by March 12, 2024. Distinctive patterns of strengthening on Sundays and Mondays, followed by sharp depreciation from Tuesdays onward, are observed due to dynamics in foreign exchange market demand. Notably, the study identifies increased depreciation during April and May, associated with the Hajj pilgrimage, and a resurgence of exchange rate pressure in mid-October due to importer demand for essential commodities. Policy implications point to the need for the Bank of Sierra Leone to adopt unconventional measures, emphasizing effective inflation-targeting policies, exchange rate stabilization, diversification of imports, and prudent foreign exchange reserve accumulation. Investments in resilient sectors like agriculture and manufacturing are crucial to reduce import dependency. In conclusion, this research reveals the relationship between exchange rate volatility and inflation in Sierra Leone while identifying a knowledge gap that warrants further investigation into the impact of geopolitical events and supply chain disruptions on exchange rates and inflation, offering valuable insights for more effective policy formulation.