Real money balances, domestic output adjustment and implications of a credit policy in Kenya

Abstract

The domestic credit component of the money supply is an important tool of monetrary and fiscal policies in Kenya. Empirical studies in Kenya have centered largely on the well defined relationship between money supply and the balance of payments. This study is an attempt to investigate the less explicit, albeit equally important relationship between money supply and the real side of the economy i.e domestic output. Of particular interest is to establish the dominant transmission mechanism of the effect of real money balances on domestic output. The study uses annual k'enyan data from 1968 to 1988 to estimate sectoral output equations deriving from a monetary model of the Kenyan economy. On the basis of our results, we find a predominantly supply side transmission mechanism- where money.balances' major effects are on current production decisions. The major conclusion is that the conduct of monetary policy to stabilize the balance of payments must take into account the output implications of changes in domestic credit. .