effectiveness of monetary policy as a to

8/18/2019 Effectiveness of Monetary Policy as a To

1/46

Effectiveness of Monetary Policy as a Tool for Controlling Inflation: A case of Kenya

Kenyatta University

A research project submitte to the !chool of Economics" in partial fulfillment of

the re#uirements for the a$ar of a %achelor of Economics an &inance 'egree of

Kenyatta University(


2/46

1

Abstract

)arious stuies have reflecte the e*istence of a positive relationship bet$een the

increase of money supply an the level of inflation( +enerally" this is reflecte by the continue

rise of prices of the various proucts( A situation ensues $here e*cess amounts of money ten to

be chasing too fe$ goos( In this perspective" this stuy teste on $hether monetary policy is an

effective tool in the combating of inflation( The ata utili,e $as erive from Kenya-s

economic situations over a range of years( The perio in perspective $as that bet$een the years

.//0 an ./0/( 'uring this perio" Kenya face various catastrophic economic events( !ome

instances of political instabilities" epressions" an economic recessions $ere vivily $itnesse(

In aition" the level of inflation $as at an all1time high( 'uring this uration" various monetary

policies an tools $ere utili,e by the Central %an2 of Kenya( As such" this range $as most

suitable for this research( The research use orinary least s#uare moel 3regression moel4 in

the eneavor( The research foun out the money supply has a irect impact on the level of

inflation( !tatistically" money supply has a statistical significance on the level of inflation in the

country( Thus" monetary policies aime at controlling the amount of money supply in the

economy" have a tremenous impact on controlling the level of inflation(


3/46

2

ABBREVIATIONS

M 1 M56E7 !UPP87

P 1 P9ICE

U!' 1 U6ITE' !TATE! '588A9

T 1 T9A6!ACTI56!

C%K 1CE6T9A8 %A6K 5& KE67A

+'P 1 +95!! '5ME!TIC P95'UCT

IT 1 I6&8ATI56 TA9+ETTI6+

) 1)E85CIT7 5& CI9CU8ATI56

%5P 1%A8A6CE 5& PA7ME6T!

CPI 1C56!UME9 P9ICE I6'E


4/46

3

Contents

0(/ C;APTE9 I(((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((( 0

0(0 Introuction(((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((0

0(. %ac2groun Analysis(((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((.

0(.(0 Monetary Policy Instruments((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((<

0(.(0(0 Interest rate policy(((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((<

0(.(0(. Minimum li#uiity asset ration((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((<

0(.(0(= 5pen Mar2et 5perations((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((<

0(.(0(> !elective Creit Control(((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((?

0(.(0(@ Inflation Targeting((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((( ?

0(.(. &ailure of Monetary Policy in 'eveloping Countries(((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((

0(= Problem !tatement(((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((0/

0(> Purpose(((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((( 0/

0(@ 9esearch Buestions((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((00

0(< 5bjectives of the !tuy((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((00

0(? !ignificance of the !tuy(((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((0.

0( limitations(((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((( 0.

C;APTE9 II((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((( 0=

.(/ 8iterature 9evie$((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((0=

.(0 Introuction((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((( 0=

.(0(0 The Classical Buantity Theory of Money(((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((0=

.(0(. Keynesian theory((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((0>

.(0(= The Monetarist Policy Theory(((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((( ((0>

.(= !pecific 8iterature(((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((( (0@

.(. +eneral 8iterature((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((0?

=(/ C;APTE9 III: 9esearch Methoology(((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((./

=(0 Introuction((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((( ./


5/46

4

=(. 9esearch 'esign((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((./

=(= Moel !pecifications((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((( ./

=(> 'efinition an Measurement of )ariables((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((.0

=(@ !tuy Area(((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((( .0

=(< Ethical Consieration((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((( (((((((..

=(? Target Population(((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((..

=( 'ata type an source((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((..

=( 'ata collection((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((..

=(0/ 'ata cleaning" coing" eiting" refining an inputting(((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((..

=(00 'ata analysis((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((.=

C;APTE9 I): 'ATA A6A87!I! A6' P9E!E6TATI56((((((((((((((((((((((((((((((((((((((((((((((( (((((((((((((((((((((.=

>(0 'escriptive !tatistics((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((( .=

>(. !ubstantive 5bjectives(((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((.

>(.(0 To establish the relationship bet$een money supply an inflation((((((((((((((((((((((((((((((((((((((((((((((((.

>(.(. To fin out the effectiveness of monetary policy in combating inflation((((((((((((((((((((((((((((((((((((((=/

>(= 'ata Analysis an Interpretation((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((=/

C;APTE9 ): !UMMA97 A6' 9EC5MME6'ATI56!(((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((==

@(0 !ummary(((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((( (((==

@(. Conclusion(((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((==

@(= 9ecommenations((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((( =>

@(> &urther 9esearch((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((=@

%ibliography((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((=<

APPE6'I A: 'ata Capture Template(((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((((=


6/46

5

1.0 CHAPTER I

1.1 Introduction

!ince time immemorial" inflation has al$ays been an issue of e*treme sensitivity( This

accrues to the fact that a case of inflation has overall effect on the prices of commoities( An

instance of spiraling" uncontrollable inflation is usually a sign of impening catastrophic oom(

Thus" the control of monetary policy has turne out to be an essential function of all

governments in the $orl( Inflation oes not necessarily have to be reflecte a continue

increase in the prices of commoities 3hyperinflation4" the vice versa can also be a reflection of

inflation 3eflation4( ;o$ever" both situations are more than unhealthy for the economy( In most

economic situations" the major reasons for the inception of inflation is a culmination of e*cessive

eman for proucts( The necessary economic policy $oul thus be entrenche on loo2ing at the

causes of an unnecessary rise( This $ay" they can thus be able to come up $ith the right

measures that can ai in controlling the e*isting overall eman in an economy( An epitome of

this can be the control of cost1push inflation $here cost is eciphere as the sole reason for an

increase in eman of both services an goos( The cost of prouction can then be chec2e so as

to combat problems relate to inflation(

To this en" various researchers have establishe the ability of monetary policy as a tool

for controlling inflation( All over the $orl" in iverse economies" monetary policy has been seen

as an approach to effectively control inflation( This is reflecte by the ability of monetary policy

in controlling the rise in eman by an increase in the available rates of interest( In aition"

monetary policy reuces the e*isting real money in the economy( A rise in the interest manages

to bring an overall reuction in collective eman in an economy( To this en" this paper aims at

loo2ing at ho$ effective monetary policy as a tool for controlling inflationD a case by case(


7/46

6

1.2 Backround Ana!"sis

Monetary policy is efine as a public interventionist action that aims at manipulating the

level an array of economic activity so as to accomplish specific" esire goals( !pecifically"

monetary policies are aime to $or2 uner t$o economic variables that affect the level of

inflation in an economy( The t$o aggregate variables are supply of money in circulation an the

respective interest rate in an economy( Monetary policy is among the fe$ tools that a national

government can utili,e to control the economy using the given monetary authority in the control

of the supply an availability of money( Controlling the availability" leaing to a control of

access" ultimately influences the eman of proucts( The la$ of eman ultimately reflects that

an increase in eman for proucts of proucts leas to an increase in prices( 'eman is in turn

influence by the availability of money in the economy( Thus" irect or inirect control of money

leas to an ultimate control of inflation(

In most instances" governments try to influence an overall level of economic activities to

be in line $ith iniviual objectives( !ome of these objectives inclue sociocultural" political"

economic" an technological objectives( +enerally" the main aim of governments is the e*istence

of a macroeconomic stability( Usually" macroeconomic stability encompasses stable prices"

economic gro$th" full employment" balance of e*ternal payment" an evelopment in a country(

+enerally" it is the job of the central ban2 of any nation to come up $ith" an implement"

monetary policies that aim at achieving stability in the e*pecte price level of proucts in a

country( ;o$ever" the major aim is to attain stability in prices so as to be able to sustain the

e*isting value of the currency in a particular country(

5n the other han" inflation refers to a persistent rise in the general price levels in an

economy( The most common instance of inflation is usually the creeping form of inflation(


8/46

7

Creeping inflation mostly occurs $hen price levels continue to rise at a level bet$een 0 percent

an < percent( In some instances" inflation manages to rise at an alarming rate reflecte a = or

more igit count( This type of inflation is referre to as hyperinflation( An epitome of

hyperinflation $as that that occurre in Kenya in the /s( 'uring this time" there e*iste a

perceive three months annuali,e rate that manage to reach a three igit figure of 0/0(0

percent in une 0=( A case of hyperinflation leas to averse conse#uences being $itnesse in

the capital" commoity" an money mar2ets( All this en up affecting the goal of ensuring price

stability in a negative form( A case of suppresse inflation refers to a scenario $here the e*isting

eman e*cees the supply but an effect on prices is minimi,e( 6ormally" minimi,ation of

prices" in the case of suppresse inflation" is manage through the use of instruments that inclue

rationing an price control( Fith respect to the above information above" monetary policy can be

utili,e to achieve a variety of objectives( In the case of this stuy" the focus $ill be on the use of

monetary policy as a tool for the control of inflation" an hence control prices in a countryD

Kenya(

All economies of the $orl eneavore to create a central ban2 as a means of

safeguaring the value of iniviual currency( In the case of integrate economies" there e*ists

geographical ban2s an one major ban2 for the respective organi,ation( &or e*ample" various

American states have feeral ban2s to chec2 on their currency( In aition" an overall control is

e*hibite by the Central %an2 of America( Instances of increase prices for proucts leas to a

iminishing value of currency( The reuce value is reflecte by a reuction in the amount of

proucts that a currency can buyD as oppose to previous ability of the same currency( This can

lea to an incience $here citi,ens of a country en up losing faith in their currency an opt to


9/46

8

e*plore other means( Among the alternatives that iniviuals engage in inclue barter trae"

holing of value in assets" or the utili,ation of other stronger" foreign currency(

In retrospective" inflation has a huge impact on the balance of payment( The impact is especially

felt in cases $here there e*ists a fi*e e*change rate system( This leas to a situation $here

e*ports en up becoming e*pensive an less an ege of competitiveness in the foreign mar2et( In

aition" imports become less e*pensive an attractive( Also" inflation eters economic gro$th

as it increases uncertainty an en up iscouraging savings through real interest rate( The real

interest rate is usually e#ual to the nominal interest rate minus the e*isting inflation rate( In

aition" long term investments are etoure from happening( This is because inflation manages

to istort availe planning by investors( Also" inflation leas to an arbitrary reistribution of

income $here those incomes fi*e on monetary term e*periencing a fall in real incomes( 'ebtors

en up gaining ue to the reuce value of currency $hile creitors lose their money( ;o$ever"

sometimes mil eman pull inflation can lea to a situation $here higher investments e*ist

leaing to higher employment( 5verall" inflation-s negative effects far out$eigh the erive

avantages that accrue from it hence a ire nee for strict control of inflation(

In aition" monetary policy is a major tool e*ploite in a battle of preserving a currency

in an economy( It usually involves the control of e*isting li#uiity in circulation in an economy

to levels perceive as consistent $ith the neee gro$th an price objectives establishe by a

government( The volume of li#uiity in circulation influences the prevailing rate of interest an

thus the relative value of the local currency against other currencies( It is the responsibility of the

monetary committee to formulate the monetary policy of the central ban2 of Kenya( Maintaining

price stability is a crucial affair for the proper functioning of a mar2et base economy( The

e*istence of price stability goes a long $ay in encouraging long1term investment an stability(


10/46

9

8o$ an stable inflation rates refer to a scenario $here price levels have no averse effect on the

ecisions of proucers an consumers(

In this case" price stability is a prere#uisite for the achievement of a $ier economic goal of

sustainable gro$th an employment( The amount of money in circulation" an the prevailing

prouctivity of various sectors" ten to influence the amount of money in circulation in an

economy( The central ban2 of Kenya strives to regulate the overall gro$th of total money stoc2

level to a state consistent $ith preetermine economic targets( Usually" the preetermine

economic targets are set by the government( They are then outline in a monetary statement( In

this scenario" monetary policy is use to control inflation cause by e*cess supply of money an

e*cess creit e*pansion" hence it ta2es the form of contractionary policy $ith an aim of

controlling prevailing e*cess supply an creit e*pansion(

1.2.1 #onetar" Po!ic" Instru$ents

There e*ist a variety of monetary policy instruments that can be utili,e in the control of

inflation( !ome of these tools inclue the follo$ing:

0(.(0(0 Interest rate policy

This arises $here the central ban2 increases the rate of interest rates for borro$ing funs( This

instrument is most applicable in cases $here ban2s turn to the central ban2s as an avenue of

securing funs( The rate that can be increase inclue the overnight borro$ing rate( This tens to

iscourage borro$ing $hich then en up reucing the rate of inflation in an economy(

0(.(0(. Minimum li#uiity asset ration

The li#uiity asset ratio is efine as the proportion of total assets being hel by a ban2( This is

usually in the form of li#ui assets an cash( This instrument is effective since it manages to

iniscriminately affect all ban2s( Also" the metho tens to be irectly establishe an the effects


11/46

10

of its implementation are felt soon after its inception( The intene purpose of the tool is usually

to create a situation $here a ban2-s free cash base is reuce( This reuces a ban2-s ability to

give our loans an avances an creates an overall reuction of availability of money( The

reuction of e*cess money supply ens up curbing prices an inflation(

0(.(0(= 5pen Mar2et 5perations

5pen mar2et operations refer to the sale or purchase of securities( The transactions usually ta2e

place in the open mar2et of the central ban2( This instrument usually targets the available cash

balances of commercial ban2s an other non1ban2 institutions( The available balances are

chec2e in relation to e*cess reserves available at the central ban2( The major aim of this tool is

the attainment of a preetermine level of reserve money( A situation of influence commercial

ban2 lening ensues hence an overall control of money supply in the economy(

0(.(0(> !elective Creit Control

These instruments prevails on the #uantitative measure of creit control that strives at

encouraging selective essential sectors of the economy $hile at the same time iscouraging

others( In one such instance" the Central %an2 of Kenya can ensue to restrict government

borro$ing up to a given e*tent( 6ormally" the given legal limit is @ percent of the most recent

auite government orinary revenues( Usually" this aims at reucing a case of e*cess

government e*peniture( A case of e*cess government spening leas to a situation of

inflationary crisis(

0(.(0(@ Inflation Targeting

This is an economic monetary inflation policy aime at achieving a specific level of inflation in

the country( This involves the setting of a certain level of inflation by the central ban2" an then


12/46

11

$or2ing to$ars achieving the given level of inflation( This is usually one through the

utili,ation of interest rate changes an other monetary tools(

'espite the embracing of the above monetary policies" many countries still fin themselves being

face by e*treme inflation rates( The rates en up eroing the value of the specific currency( A

evaluation of currency ens up creating an unfavorable balance of payment an hence a

culmination of ebts an eficit bugets( In this perspective" thir $orl countries continue to

remain poor espite their rigorous eneavors aime at escaping the unfavorable economic

situation(

In times of political tumult" monetary policy also tens to be ineffective in cases of political

turmoil( The matter is further aggravate $hen political instability combines $ith economic

shoc2s( This leas to a culmination of e*treme inflation being $itnesse in a country( An epitome

of this $as $itnesse in Kenya uring the post1election violence of .//?G.//( The prices of

basic commoities soare to the e*tent that they $ere virtually impossible to the average man( In

aition" the monetary policies set out to correct out the situation ene up being ineffective in

the control of the ensuing inflation( Economic shoc2s such as epressions" recessions" an booms

also rener monetary policies ineffective( This $as $itnesse uring the .//G/ economic

recession( 'uring the recession" major $orl economies face harsh circumstances espite

having $ell formulate monetary policies in place( The available strategies faile to stir the

economy bac2 to stability(

1.2.2 %ai!ure o& #onetar" Po!ic" in 'e(e!o)in Countries

'espite the $iesprea success of monetary policies" there e*ists a tenency of failure of the

policy in eveloping economies( The failure can be attribute to a myria of reasons( !ome of

the reasons inclue the follo$ing:


13/46

12

i4 In eveloping economies" mar2ets an financial institutions ten to be highly

isorgani,e( Most of these countries operate uner a ual monetary policy system

$ith a small organi,e money mar2et catering to the financial re#uirements of

mile" an upper class( In aition" the mar2ets cater for the largely isarrange

money mar2et the lo$ income iniviuals only turn to in times of nee( The lac2 of

$ell1evelope capital an money mar2ets an a limite #uantity an range of

financial assets creates an atmosphere that leas to the failure of monetary policy(ii4 Most of the ban2s in eveloping economies are but sub1branches of giant"

international ban2s( Thus" in the event of being s#uee,e by local authorities" they

can turn to their parent companies( This leaves them $ith an unlimite supply of

funs ening up reucing the effectiveness of monetary policy( &or e*ample" %arclays

%an2 Kenya is just a sub1branch of a larger ban2(iii4 In some instances" monetary policies en up being misuse by the authorities( This

leas to a situation $here the monetary policies fail to aress the situation at han(

Choosing the right mi* is thus essential in the fight against inflation( !ome instances

of inflation re#uire the use of fiscal policies as oppose to monetary policies(iv4 In thir $orl countries" commercial ban2s ten to have e*cess funs ue to lac2 of

viable projects an borro$ers( This reuces the sensitivity of their cash base( In this

case" the effectiveness of open mar2et operations ens up being severely limite(

v4 The e*istence of high levels of corruption ens up renering some instruments li2e

selective creit control to be ineffective(

vi4 Illiteracy in the eveloping countries ensures that iniviuals have little or no

2no$lege on the $or2ing of monetary policy( This reuces the effectiveness of

monetary policy(


14/46

13

vii4 Most iniviuals in eveloping countries prefer personal storage of money as

oppose to ban2 eposits( This ens up reucing the effectiveness of Central %an2-s

eneavors(

viii4 In aition" the e*istence of a lin2age bet$een lo$ interest rates" e*pane output"

an higher investments is evoi( This is base on the fact that investment ecisions

are not sensitive to the prevailing interest rates" or movement( This creates a situation

$here e*pectation plays a major role in etermining investment( In retrospective"

e*istence of inflation leas to a situation $here interest rates are negative( Also" the

e*istence of structural" bureaucracy" supply constraints" an absence of intermeiate

proucer play a role in limiting e*pansion of output even in situations $here eman

increases leaing to an increase in inflation( In this setting" public sector investment"

an essential component" ens up losing sensitivity to changes in interest rates(

1.* Prob!e$ State$ent

'espite the embracing of monetary policies by eveloping countries" most of them still fin

themselves entrenche in a never ening cycle of inflation( The cycles of inflations en up

estroying counties- prie" an to some e*tent" their sovereignty( This loss is erive from the

fact that the countries fin themselves up to their nec2 $ith ebts resulting from a $ea2 currency

eroe by inflation(

In aition" monetary policies en up being inefficient uring turbulent times( !ome of these

times inclue times of political instabilities li2e Kenya-s Post Election )iolence( 'uring this

time" prices of commoities soar up to a ne$ level( 5ther times inclue instances of economic

booms an recessions( This $as $itnesse in the latest $orl economic recession( Even

economic giants $ere unable to protect themselves from the scourge that $as an economic

recession(


15/46

14

1.+ Pur)ose

This research-s main purpose $as to loo2 into some of the factors that ten to rener monetary

policies ineffective( In aition" the paper loo2e into the availability of other policies that can

ai in the control of inflation in case of a failure in the monetary policy( In this case" there e*ist

three notable operation lags( These lags inclue the follo$ing:

i4 Po!ic" ,a- This escribes the time that it ta2es to pursue ne$ policies at the onset of

a perio of change in an organi,ation or e*istence of the nee for change(

ii Outside ,a- This represents the perio that lapses bet$een the inception of a ne$

policy change an the onset of the effects of the change in the economy(

iii Reconition !a- This refers to an actual elapse tie that arise bet$een an actual nee

for a policy action an the onset of a reali,ation that such a nee has been incepte(

+enerally" this lag e*ists because economic ata ta2es some time to collect" an also

$ith accurate ata reasonable iniviuals re#uire me to arrive at a share verict(

1./ Researc uestions

Is the current monetary policy system ae#uate in tac2ling an accomplishing objectives

of attaining a constant price levelH Is the Central %an2 of Kenya effective enough in its regulation of the stoc2 an

accessibility of moneyH

;o$ $ell1suite is the monetary policy to other policies as the fiscal policy in its

objective of attaining price stabilityH

Are there any other policies that can aress the problem of inflation better than the

current policiesH

;o$ ae#uate is the monetary policy in safeguaring the value of moneyH

1. Ob3ecti(es o& te Stud"

The objectives of the stuy revolve aroun e*ploring the significance an the suitability of the

monetary policy in reali,ing macroeconomic goals( !ome of these macroeconomic objectives


16/46

15

inclue price stability" economic gro$th" full employment" an a favorable balance of payment(

These objectives are uly stipulate in the Central %an2 of Kenya-s Amenment Act(

!pecific 5bjectives

The specific objectives of the stuy are as outline belo$:

Establish the relationship bet$een money supply an inflation(

&in out the effectiveness of monetary policy in the combating of inflation(

&in out the efficiency of the Central %an2 of Kenya in controlling the supply an

availability of money(

&in out $hether monetary policy is $ell establishe to enable the safeguaring of the

value of Kenyan currency(

Ientify if there e*ist any other viable policies that can be use to combat inflation(

1.4 Sini&icance o& te Stud"

The stuy $ill be useful to the government" the Central %an2 of Kenya" an other !ta2eholers

$ho are involve in the formulation of monetary policies( In aition" the research $ill come in

hany in helping in the management of both monetary an fiscal policies to enable better control

of the economy( In this perspective" the research $ill ai in the elimination of the various

operational lags that affect the implementation of monetary policy(

1.5 !i$itations

The perio available for carrying out the research $as minimal( This because there e*iste much

ata applicable to the research( In aition" resources available for carrying out the research $ere

limite( Therefore" the available resources $ere utili,e in the best possible $ay(


17/46

16


18/46

17

CHAPTER II

2.0 ,iterature Re(ie6

2.1 Introduction

Theory has propose several $ays in $hich inflation can be combateD this chapter is concerne

$ith the literature that le to the use of such instruments an policies( To enable us unerstan

the prepositions mae the stuy analy,e several theories:

.(0(0 The Classical Buantity Theory of Money

This theory $as evelope by Irving &isher( &isher too2 the vie$ that money $as only use as a

meium of e*change to settle transaction involving the eman an supply for goos an

services(

The #uantity theory of money can be evelope to a theory of price levels(

!ince M)PT

PM)GT

Fhere )1velocity of circulation M1money supply

P1price T1#uantity of transactions

Assuming that ) an T are roughly constant" P $ill vary irectly $ith increase or

ecrease in the amount of M an it changes in money supply 3M4 that causes the prices 3P4 to

change" not changes in price that cause the changes in supply is assume to be constant as the

economy in #uestion is assume to be operating at full employment( If the velocity of circulation

) is more or less constant than any gro$th in money supply 3M4 over an above the potential of

the economy to increase" T $ill cause inflation( This is then consistent $ith the monetary policy

to curb inflation by controlling the money supply in the economy as it leas to inflation(


19/46

18

A further notable feature in this theory is that the government monetary policy shoul allo$

some gro$th in money supply if the economy is gro$ing but not let the gro$th in money supply

to get out of han as if output in the economy 3T4 is gro$ing an the velocity of circulation 3)4

is constant then a matching gro$th in the money supply of money is neee to avoi eflation(

.(0(. Keynesian theory

Keynes argue that an increase or ecrease in money supply only affects" only inirectly" the

eman for goos an services an hence the level of income though a change in the rate of

interest thus for e*ample an increase in money supply leas to a fall in the rate of interest $hich

in turn causes private investment to fall an ultimately results in a ecline in the level of national

income( The impact on the economy of the increase in money supply epens on the effect that

the interest rates prouces (accoring to Keynesian vie$ "both investment eman an consumer

eman are relatively insensitive to interest rate changes( That is $hy they interest in1elastic(

Keynes argue that the volume of investments- epens heavily on technological changes an

business confience an e*pectations" hence an increase in the supply of money supply $ill have

a limite effect on aggregate eman an conse#uently relatively little effect on output an

employment( Keynesian argue that monetary policy $ill have limite effect on the economy an

national income "because increase in money supply $oul be neutrali,e by the reuctions in the

velocity of circulation leaving PT unaffecte (accoring to Keynes increase in money supply

cannot lea to a proportional increase in the price level(

.(0(= The Monetarist Policy Theory

Monetarists argue that since money is a irect substitute for all other assets "an increase in the

supply of money supply "given a fairly stable velocity of circulation" $ill have a irect effect on

the eman for other assets since there $ill be more money to spen on those assets( If the total


20/46

19

output of the economy is fi*e" then an increase in the money supply $ill lea irectly to higher

prices(

Monetarists therefore reach the same conclusion as the ol #uantity theory of money that a rise in

money supply $ill lea irectly to a rise in prices an probably also to a rise in money incomes"

an increase in real output an so an increase in employment( In the long run ho$ever" they argue

that all increases in the money supply $ill be reflecte in higher prices unless there is a long1

term gro$th in the economy( Monetarist school of economic thought contene that money

supply is a 2ey eterminant of the level of prouction the short run an the rate of inflation in the

long run( In orer to minimi,e uncertainty monetarist avocate for the maintenance of a

constant rate of gro$th of money supply(

2.* S)eci&ic ,iterature

Kenya li2e many other eveloping countries has epene on monetary policy in orer to

achieve price stability "economic gro$th an evelopment" positive balance of payments an full

employment (the follo$ing is a revie$ of ho$ the instruments have been use to attain stability

in the economy in Kenya( In 0?/ the country recore a balance of payment 3%5P4 eficit of

=


21/46

20

To contain any reuction in +'P the Central %an2 aopte a selective creit control an special

attention $as given to the interests of marginal traers an prouctive agents in Agriculture( In

0?= inflation rate rose to 0@ percent reflecting a sharp increase in money supply partly ue to

t$o consecutive surpluses on %5P an the increase in private sector borro$ing( In response to

this the C%K introuce a limit gro$th of private sector creit to a ma*imum of 0. percent p(a

an e*tene the 0@ percent li#uiity ratio re#uirement together $ith a restriction of local

borro$ing by foreign controlle companies to ma*imum of // million for the year 0?= an the interest rates $ere raise both in

saving eposits an avances but all these efforts i not the %5P eficit from reaching >=>

million an inflation rate from rising to 0< percent accompanie by a slo$o$n in output

gro$th of > percent( The coffee boom $hich laste 0?< to 0?? mar2e another phase of

Kenya-s monetary policy( &oreign e*change reserves hel by C%K increase by .// million

accompanie by a surplus in %5P by ?? million to .0?< million (To avoi inflation the C%K

raise the li#uiity ratio of commercial ban2s to 0 percent an increase the lening rate to 0/

percent( !urprisingly in 0? the %5P eficit increase to0>< million as the omestic creit

gre$ at =@ percent( Money supply increase by 0> percent $hile +'P gre$ by only ? percent(

This le to an imposition of a higher li#uiity ratio of ./ percent an a cash ratio of > percent

$hich $as later reuce to 0 percent an = percent respectively as the li#uiity situation $as

e*tremely tight(

These mechanisms yiele positively an %5P surplus of 0>= million $as recore in 0?"

though it cause money stoc2 to increase by 0< percent an omestic creit rose by 0= percent

an government borro$ing increase to 0=.= million( In 0? there $as a thrust in the C%K


22/46

21

management of monetary policy as bugetary an fiscal policy operations seeme to unermine

the monetary policy( An important objective of monetary an fiscal policies since 0> $as to

control creit allocation bet$een the government an the private sector though by en of 0>

the government share of creit amounte to .(? percent of total( This le to a continue %5P

eficit though this $as improve in 0< o$ing to another coffee boom( It $as then clear that a

far reaching reform incluing improvement in the effective of the monetary policy neee to be

put in place( This le to the introuction of treasury bons" open mar2et operations reiscount

an avance facilities that are use up to ate(

2.2 7enera! ,iterature

Tetangco 3.//


23/46

22

Calener an 'aane 3.//=4 inflation targeting re#uires a forecast of inflation an an estimate of

ho$ inflation is li2ely to be affecte by changes in monetary policy instruments( The pursuit of

lo$ inflation by means of any techni#ue re#uires the same things for e*ample the use of

monetary targets has to be base on an assumption about the relationship bet$een current

monetary gro$th an future inflations an if the policy instrument is interest rates an future

monetary gro$th(

!vensson 3.//?4 a successful inflation targeting policy is characteri,e by

i4 the announcement of the numerical inflation target

ii4 an implementation of monetary policy that gives a major role to an inflation forecastiii4 an aoption of short term interest rates as the only monetary instrument an

iv4 A high egree of transparence an accountability(

Proponents of inflation targeting 3%erman2e et al" 0 6aal 'e !imone" .//0D Carbe"

8inererretche" an !chmit1hebbel .//.4 emonstrate empirically that inflation targeting

associate $ith the improvement in overall economic performance( Accoring to this author the

rationale behin this success is that by targeting irectly price" inflation target plays a role of

e*plicit an strong nominal anchor( The implications of inflation targeting policy necessitates

that monetary authority announces the numerical target (The central ban2 shoul also set out the

perio $ithin $hich inflation $ill reach the target level(

The results of ifferent stuies suggest that inflation levels" persistence" an volatility are lo$er

in inflation targeting countries than in non1targeters( ohnson 3.//=4 provies a strong evience

of an immeiate fall of inflation e*pectations after an aoption of inflation targeting( 8evin"

6atalucci an Piger 3.//@4" Palan,uela 3.//=4 they argue that inflation e*pectations are more

anchore for targeters than for non1targeters particularly at longer hori,ons( Conse#uently the


24/46

23

supporters of this vie$ claim strongly that monetary policy has become more efficient uner

inflation targeting(

Anre$ +( 3./0/4 6igeria shoul stop access to borro$ing as this may lea to an increase in

prices( The more the government borro$s the more it increases the supply $hich $ill lea to

high aggregate eman encouraging firms to raise prices of their goos an services (Tight

monetary an fiscal policies coul also be the solution to inflation( 'avi '( 3.//@4 $ith

inflation targeting" our policy are more forecast" our communication clearer an inflation

e*pectations more solily anchore( !haron 'avies 3./004 !outh Africa has successfully pursue

inflation targeting monetary policy $ith a range of =1< percent on a continuous basis since

.//?(This policy has encourage a stable an sustainable economy that has seen an increase in

the annual gro$th rate to an average of =(@ percent since 0 an above < percent for .//?(

The Peoples %an2 of China 3P%5C4 increase its benchmar2 lening an eposit rate for the

secon time this year as the government continues to battle against surging prices( 8a

'ao2ui3./0/4 a member of the monetary policy committee $ith the3P%5C4sai the rate hi2e

$as mainly aime at managing inflationary e*pectations an reflecte the policy shift as

tightening the money supply is the best $ay to curb inflation( %esies interest rates hi2e China

has also increase the ban2 reserve ratio si* times in ./0/ to 0(@ percent an 0 percent for

some large commercial ban2(


25/46

24

*.0 CHAPTER III- Researc #etodo!o"

*.1 Introduction

This chapter covers the methoology for this research project( In assessing ho$ monetary policy

is use to control inflation this research utili,e the orinary least s#uare metho 3regression

moel4 to analy,e ho$ the variables of monetary policy influence inflation(

*.2 Researc 'esin

This stuy utili,e #uantitative ata collecte from Kenya 6ational %ureau of !tatistics3K6%!4

ournals "economic revie$s" Central %an2 of Kenya proposals an journals "Forl %an2

economic revie$s an strategies among others( The ata $as use to analy,e the effects of

money supply" commercial ban2s interest rates" an foreign e*change rates 3K!;GU!'4 on

inflation rates in Kenya( The ata use covere a ten year perio from .//0 to ./0/ of the

respective average annual variables liste above (The ata $as regresse in orer to give the

values for further analysis carrie out in chapter four of this research(

*.* #ode! S)eci&ications

The moel use in this stuy is regression moel an particularly multiple regression moel as

inflation rate is assume to epen on a number of several variables $hich areD money supply"

interest rates" an foreign e*change rates 3K!hsGU!'4

89bo:b1;:b2 3:b*k:e

Fhere

81represents the rate of inflation

b01this gives the inflation rate $hen all other variables are ,ero


26/46

25

> 1the commercial ban2s interest rates

b11 coefficient of money supply1 It $as use to measure ho$ a unit change in money

supply changes the inflation rate

b21 coefficient of foreign e*change rate1 It $as use to measure ho$ a unit change in

foreign e*change affects the rate of inflation

b*1 coefficient of commercial ban2s interest rates J It $as use to measure ho$ a unit

change in interest rates affects the rate of inflation(

e1the error term(

The rate of inflation 34 is the epenent variable $hile money supply interest rates an foreign

e*change are the inepenent variables

*.+ 'e&inition and #easure$ent o& Variab!es

&our variables $ere utili,e in this research an they $ereD inflation rate" money supply" foreign

e*change rates an commercial ban2s interest rates

Inflation is measure by a change in consumer price ine* 3CPI4

Commercial ban2s interest rates is measure by averaging the mean mar2et annual interest rates

for Kenya-s commercial ban2s

Money supply m. is the money hel by public in form of cash" travelers che#ues" current

accounts" saving eposits plus small time fi*e eposits(

&oreign e*change rate is the average annual prevailing foreign e*change rate bet$een Kenya

shillings an U! ollars(

*./ Stud" Area

The stuy area in the research $as the $hole country( Thus" ata utili,e for the research $as the

country-s national ata(


27/46

26

*. Etica! Consideration

'ata collecte $as seconary an thus minimal ethic issues arose( ;o$ever" $here ata

$as of a confiential nature" it collecte after see2ing authori,ation from the national registration

agencies or respective organi,ations( This $as after pleging utmost confientiality an

promising that the ata $oul be utili,e for research purposes only( After verification of the

ata" $hich forme the population for this research" any confiential information $as elete(

The ata collecte $as solely use for this research an a lot of care $as ta2en to ensure that any

sensitive information i not lea2 to unauthori,e iniviuals(

*.4 Taret Po)u!ation

Accoring to Mugena an Mugena 0 a target population is a population to $hich a

researcher $ishes to generali,e the research stuy hence the target population in this stuy are

the persons involve in ma2ing business an economic policies of this country( Inclue also are

researchers an stuents pursuing any business or economic relate courses(

*.5 'ata t")e and source

This research mainly relie on seconary ata obtaine from $ritten materials $hich inclue

publications from 6ational statistics bureau of Kenya 3K6%!4"publications from the Central

ban2 of Kenya "$orl %an2 an from the internetD amongst others(

*.? 'ata co!!ection

The ata use in this research $as collecte through stuies" observations an from publishe

materials(

*.10 'ata c!eanin@ codin@ editin@ re&inin and in)uttin

To permit #uantitative analyses ata must be converte into numerical coes representing

attributes or measurement of variables 3Mugena an Mugena 04( ;o$ever" since this


28/46

27

research utili,e seconary ata entirely there $as no nee for ata coingD as all ata use $as

#uantitative in nature( The ata $as further inputte in a computer for further analysis(

*.11 'ata ana!"sis

The inputte ata $as then presente in the form of tables" graphs an pie charts (This provies

for an easier analysis an interpretation of the ata inputte( &urther the ata $as then regresse

to obtain t1values " p1values " specific coefficients an intercepts" stanar errors among other

values at given significance levels (These values $ill be use for further analysis(

CHAPTER IV- 'ATA ANA,SIS AN' PRESENTATION

+.1 'escri)ti(e Statistics

This chapter gives ata analysis an presentation in graphs enabling interpretation of the results(

The results of the analysis $ere use in the ma2ing of conclusions an recommenations( The

graphs belo$ represent the collecte ata(

The follo$ing table sho$s the average annual rates of inflation in Kenya from .//0 to ./0/(

EAR 2001 2002 200* 200+ 200/ 200 2004 2005 200? 2010

IN%,ATION

RATE

@( .(/ ( 00( (? (= 0(0


29/46

28

Te &o!!o6in diara$ so6s te !ine ra) o& te abo(e data

2001 2002 2003 2004 2005 2006 20007 2008 2009 20100

2

4

6

8

10

12

14

16

18

Infation

Infation

&rom the above iagram it-s seen that inflation rate in Kenya has been rising an falling at

ifferent times( It $as lo$est in .//." then in the follo$ing year it rose to a rate of ( then it

graually rose to 00(< before falling to 0/(= in .//@(It $as highest in .// an this coul be

attribute to post election violence an the Economic crisis that hit the $orl uring that time(


30/46

29

The follo$ing table sho$s money supply in Kenya an the inflation rates over the same perio

of time from .//0 to ./0/(

The money supply is in hunres of billions( This value has been converte to hunres of

billions for an easier analysis to ma2e the ata in the table have the same range(

7EA9 .//0 .//. .//= .//> .//@ .//< .//? .// .// ./0/

I6&8ATI5

6 9ATE

@( .(/ ( 00( (? (= 0(0

M56E7

!UPP873

K!hs

hunres

of billions4

=(>=/

/<

=(>?

>=

=(.

/?

=(0?

0

=(.0

=(@<

.=

>(>?/


31/46

30

%elo$ is a line graph sho$ing the relationship bet$een the rates of inflation an the money

supplyD

2001 2002 2003 2004 2005 2006 2007 2008 2009 20100

2

4

6

8

10

12

14

16

18

Chart Title

Infation Money Supply

&rom the above iagram it-s evient that there is a positive relationship bet$een money supply

an the rates of inflation( The rate of inflation rises or falls graually as the amount of money


32/46

31

supply increases or reuces( Though there are some areas that o not seem to follo$ this tren

this can be attribute to other non1economic factors as political instability" tribal violence an the

contagion of $orl economic crisis(

The follo$ing table sho$s the rates of inflation an the foreign e*change rates in Kenya for a

perio of ten years from .//0 an ./0/(

7EA9 .//0 .//. .//= .//> .//@ .//< .//? .// .// ./0/

I6&8ATI56 9ATE @( .(/ ( 00( (? (= 0(0

&59EI+6

EC;A6+E

9ATE3K!;GU!'4

?(< ??(/? ? ??(=

>

?.(=?< /


33/46

32

e*change rate means that the Kenyan shilling is epreciation against the ollar (this usually

favors e*portation an ma2es importation more e*pensive an since Kenya is a major importer

of oil proucts an other basic proucts such foo stuffs this usually has averse effects on our

economy( This leas to increase inflation as sho$n by the above iagram( Fhen the foreign

e*change rate rises 3omestic currency epreciates4 the rate of inflation also rises an $hen it

falls the rate of inflation also falls( This sho$s that there is a positive relationship bet$een the

rate of inflation an the foreign e*change rate(

The follo$ing table sho$s the rates of inflation an commercial ban2s interests- rates for a

perio of ten years from .//0 to ./0/(

7EA9 .//. .//. .//= .//> .//@ .//< .//? .// .// ./0/

I6&8ATI56 9ATE @( .(/ ( 00( (? (= 0(0

C5MME9CIA8 %A6K

I6TE9E!T 9ATE!

0(> 0(=> 0=(>? 0.(.@ 0=(0< 0=(?> 0=(=. 0>(? 0>(?< 0>(=

The follo$ing line graph sho$s the relationship bet$een the commercial ban2s interests- rates

an the rate of inflation(


34/46

33

2001 2002 2003 22004 2005 2006 2007 2008 2009 20100

5

10

15

20

25

Chart Title

Infation Co$$er"ial %an& Intere't #ate'

&rom the above iagram $hen commercial ban2s interest rates increases the rate of inflation

falls( Though there are some mi*e reactions at some points this coul be attribute to the other

factors that affect inflation incluing money supply" foreign e*change rates an other non1

economic factor as political an social instability among others( Increase in interest rates is one

of the most commonly use policy by the Central %an2 of Kenya to control inflation this can be

sho$n by the recent increase of the base lening rate from @ percent in ./0/ to the current rate

of 0


35/46

34

9ATE34 !UPP87343in

K!hs hunres

billions4

&59EI+6

EC;A6+E

9ATE!34

%A6K! I6TE9E!T

9ATE!3K4

.//0 @( =(>=//< ?(< 0(>

.//. .(/ =(./? ??(/? 0(=>

.//= ( =(>?>= ? 0=(>?

.//> 00( =(0?0 ??(=> 0.(.@

.//@ (? =(00? ?.(=? 0=(0<

.//< (= >(./.> ?/


36/46

35

Regression Statistics

Multiple 9

/(?0@?0/

>

9 !#uare

/(@0>

.

Ajuste 9

!#uare

/(.?>@=0?=

!tanar Error >(//0?@<

5bservations 0/

A65)A

df SS MS F Significance

9egression = 0/.(@=@?< =>(0?@? .(0=@.<

9esiual < .> 0/>

Total 0(0=@

.@(/?>@@? 1?(>0/>/

@(>??.0<

=(/.>0/@?>. 10(=.=.<

/(.=.==@@

/(.?>??>/??.?@> /(>.0/=?< 1/(>=>0>

K

1

/(>/.

. /(


37/46

36

b0 = -18.042 1 this is the rate of inflation $hen all other factors are ,ero( This means that there

$ill be a eflation rate of 0(/>. $hen money supply" foreign e*change rate an commercial

ban2 interest rates are ,ero(

b1 = 5.478 J coefficient of money supply (this means that inflation rate increases at a rate of

@(>? $hen money supply increases by 0// billion(

b2=0.233 Jcoefficient of foreign e*change rate (this means that the rate of inflation increases by

/(.== $hen foreign e*change rates increases by one( This can also be interprete as $hen the

omestic currency epreciates by one the rate of inflation increases by /(.==(

b3=-0.8403 Jcoefficient of commercial ban2s interest rates( This means that the rate of inflation

ecreases by /(>/= $hen commercial ban2s interest rates increases by one

Interpretation of p- values

X - 0.1204 This means that money supply is significant at 0/ percent significance level(

J –0.4291 This means that foreign e*change rates are not significant at either 0 percent"@

percent or 0/ percent significance levels(

-0.2347 ! his means that commercial ban2s interest rates are not significant at 0 percent"@

percent or 0/ percent significance levels(

Interpretation of re"ression statisti#s

$ultiple % = 0.72

This is the correlation coefficient (it means that there is a strong linear relationship bet$een the

rate of inflation an the factors affecting it that" money supply" foreign e*change rate an interest

rates(

% s&uare =0.52


38/46

37

This is the coefficient of etermination( It means that @. percent of the variations in inflation

rate can be e*plaine by variations in money supply" foreign e*change rates an commercial

ban2s interest rates(


39/46

38

CHAPTER V- S##AR AN' RECO##EN'ATIONS

/.1 Su$$ar"

The broa objective of this stuy $as to establish the effectiveness of monetary policy as a

tool for combating inflation( The variables investigate $ere the level of inflation" commercial

ban2s interest rates" money supply an the foreign e*change rate 3measurable in ollars4D from

Kenya( The research evolve from the continue inefficient use of monetary policies in Kenya(

The ata collecte $as seconary in nature an a tren analysis carrie out to investigate the

effectivenss of monetary policy in controlling the level of inflation( The orinary least s#uare

metho 3regression analysis4 $as utili,e in the analysis of the ata collecte( 9egression

analysis is a tool commonly utili,e in the etermining of the e*istence of a relationship bet$een

variablesD using historical ata(

In aition" escriptive statistics $ere utili,e in the analysis of the ata collecte(

+raphs $ere also use in the stuy to represent the ata( The stuy carrie out regression through

the utili,ation of Microsoft E*cel( &rom the stuy" it is evient that monetary policies have a role

to play in the control of inflation( Thus" monetary policy" as a tool for controlling inflation" is

effective(

/.2 Conc!usion

&rom the analysis" money supply $as foun out to be most significant factor affecting the

rate of inflation( Fhen money supply increases by one hunre billion the rate of inflation

increases by @(>?( This being so" then it means that any increase in money supply shoul be

manage to a level that allo$s the economy to gro$ an also high enough to avoi eflation3a

situation $here the prices are falling4 This is ue to the fact that" if money supply is ,ero an the

other factors are also ,ero" there $ill be a eflation of 0(/>.( This means that the economy is


40/46

39

not gro$ing hence aversely affects the other objectives of macroeconomics( Also" it is evient

that there e*ist a positive relationship bet$een increase in foreign e*change rate an the rate of

inflationD $hen the currency epreciates at a rate of one" inflation increases at a rate of /(.==(

Therefore efforts shoul be mae to avoi any rise in foreign e*change or any epreciation in the

omestic currency(

Also" this research sho$e that there e*ist a negative relationship bet$een the rate of

inflation an the commercial ban2s interest rates( Fhen the commercial ban2s interest rates

increase by one percent" the rate of inflation reuces by /(>( Thus" increase in interest rates is

one $ay of controling the rate of inflation( ;o$ever" the rates of interest shoul be manage at a

level that oes not hurt investments as high interest rates hiners investments an this leas to

poor economic gro$th hence it aversely affects the other macroeconomic objectives(

Apart from the macroeconomic variables iscusse above it-s also evient other factors

influence the rate of inflation( !ome these factors inclue political instability" tribal clashes

"international financial crisis3recession an epression 4 amongst others( Inflation targeting

3$here the monetary authorities set a certain target an manages the macroeconomic variables

to$ars achieving that inflation rate4 as policy shoul also be use as this has sho$n positive

results in some parts of the $orl such as !outh Africa(

/.* Reco$$endations

&rom this research it is evient that commercial ban2s an the entire ban2ing sector play

a very vital role in the implementation of the monetary policies( ;ence" there e*ist a nee for the

active co1operation an harmony bet$een the ban2ing sector an the monetary policy authorities

in terms of policy formulation an ecision ma2ing( This is sho$n by the fact that commercial

ban2s interest rates influence the rate of inflation by 1/(> for every unit rise in interest rates(


41/46

40

It-s e#ually important also to ma2e all the efforts necessary to avoi evaluing the

omestic currency or controlling any factors that can lea to its epreciation as $e have seen that

inflation increases by /(.== $hen the omestic currency epreciates by one unit(

Moreover money supply shoul also be increase at a rate that is consistent $ith the gro$th of

the economy as it-s evient from this research that an increase in money supply by 0// billion

increases the rate of inflation by @(>? if it is not accompanie by an e#uivalent gro$th in the

+ross 'omestic Prouct 3+'P4(!imilarly its ecrease beyon a certain level leas to eflation

hence it shoul also be avoie( Also" there e*ist a nee to harmoni,e the fiscal an the monetary

policies as one $ithout the other achieves less success( Fith a $ell1manage monetary policy it

is possible to 2eep the price levels o$n although some unpreictable economic shoc2s may ten

to estabili,e the effects of these policies(

In a nutshell" it is $orth noting that the monetary policy has been use successfully in

many of the major $orl economies such as U!A" China" an !outh Africa an among others to

achieve price stability" increase employment level" promote economic gro$th an evelopment

an also to achieve positive balance of payments(

/.+ %urter Researc

The follo$ing are the areas for further stuy

The e*istence of social factors that impact on the rate of inflation

The use of inflation targeting as policy measure that can be use to combat inflation

The relationship bet$een economic shoc2s an monetary policy(


42/46

41


43/46

42

%ibliography

%all" 8(" L !herian( 3.//4( 'oes Inflation Targeting MatterH The Inflation Targeting 'ebate( In

F( M" L %( !( %ernan2e" Inflation Targeting Lessons fro! t"e International E#perience

3pp( .>1.?


44/46

43

;eint," (" L 6i2umana" 8( 3./0/4( Is t"ere a case for for!al inflation targeting in su+-Sa"aran

,frica) Accra: African 'evelopment %an2 +roup(

Ine*Muni( 3./0.4( .en%a Inflation Rate 1Consu!er Prices2( 9etrieve 5ctober 0>" ./0." from

Ine* Muni: http:GG$$$(ine*muni(comG2enyaGinflationrate

percent.consumerprices percent.(html

International Monetary &un( 3.//?4( .en%a Povert% Reduction Strateg% ,nnual Progress

Report - 34463447) Fashington '( CN: International Monetary &un(

International Monetary &un( 3.//4( .en%a 3448 ,rticle I Consultation - Staff Report: Staff

Supple!ent: Pu+lic Infor!ation ;otice on t"e E#ecutive 'oard *iscussion: and

State!ent +% t"e E#ecutive *irector for .en%a) Fashington" '(C(: International

Monetary &un(

.en%a Econo!ic Statistics and Indicators( 3./0.4( 9etrieve 5ctober 0>" ./0." from Economy

Fatch: http:GG$$$(economy$atch(comGeconomic1statisticsGcountryGKenyaG

Muia" 9( 3.//=4( Modern Econo!ics) 6airobi: &ocus Publication 8imite(

6aal" '( &( 3.//04( Inflation Targeters in Practice" A luc2y lotH Contemporary Economic Policy(

Conte!porar% Econo!ic Polic%" .=1.@=(

6ungOu" 6(" Aam" C(" Maturu" %(" L 5OConnel" !( 3./0/" April4( 'uilding a .en%an Monetar%

Regi!e for t"e 3st Centur%) 6airobi: Central %an2 of Kenya(

9otich" ;(" Kathanje" M(" L Maana" I( 3.//?4( , M


45/46

44

The Central %an2 of Kenya( 3./0.4( Monetar% Polic%( 9etrieve from Central %an2 of Kenya:

http:GG$$$(centralban2(go(2eGine*(phpGmonetary1policy


46/46

45

APPEN'I< A- 'ata Ca)ture Te$)!ate

7EA9 I6&8ATI56

9ATE34

M56E7

!UPP87343in

K!hs hunres

billions4

&59EI+6

EC;A6+E

9ATE!34

C5MME9CIA8

%A6K!-

I6TE9E!T

9ATE!3K4

.//0 @( =(>=//< ?(< 0(>.//. .(/ =(./? ??(/? 0(=>

.//= ( =(>?>= ? 0=(>?

.//> 00( =(0?0 ??(=> 0.(.@

.//@ (? =(00? ?.(=? 0=(0<

.//< (= >(./.> ?/

effectiveness of monetary policy as a to

Documents