The relationship between monetary policy and gross domestic product in Kenya

Abstract

This study sought to establish the relationship between Monetary Policy and GDP in Kenya. GDP no doubt is affected by the Monetary Policy of the state. Among the monetary policies that the CBK adopts in intervening the Kenyan economy, Open Market Operation is the one which is most frequently used due to its easily observable effect and relatively low cost during operation. Via buying and selling treasuries the C.B.K adjusts the money supply in the market and manipulates the economy. In recent years, a modern practice of this policy is used by the CBK which targets the money market funds rate to control the money supply. The research papers of various authors have been studied in this regard to prove the Hypothesis and after in depth analysis by applying Regression Analysis technique it has been observed that the relationship between the two exists. The data of past 10 years of Kenya has been used for driving the conclusion. The study proved that the Growth in Money Supply greatly affects the GDP of an economy, obviously various unknown factors also affects the GDP. This research shows that Monetary Policy has a Positive relationship with GDP although the relationship is not that significant. This positive relationship can be explained by the fact that the level of Money Supply in the economy influences the purchasing power of firms, Individuals and also the Expenditure of the Government. The research further shows that the Rate of Growth of Labour, EXPO, Government Expenditure and Aggregate Investment also do not have a significant determinant on the rate of growth of GDP. In addition, Money Supply the variable of interest was found not to be a significant determinant of GDP in Kenya this is because there are structural weaknesses in the financial sector such as weak legal framework, poor governance, and insufficient infrastructure, which have contributed to high interest rate spreads, inadequate financial intermediation and heightened risks and therefore hamper the transmission mechanism of monetary policy. This is also because when the CBK is targeting a certain interest rate (repo rate) to control the money Supply it is the GDP that influences the level of Money Supply in circulation and not Money Supply affecting the output.