Relationship Between Monetary Policy Tools and Inflation in Kenya

Abstract

Inflation is a critical aspect of every economy and presents a balancing act to most governments through regulatory framework. Inflation can break or break the economy of a nation. Hence policy makers in the government regulating bodies spend considerable time in developing policies aimed at achieving set targets of inflation which are geared to supporting the broader economic objectives of an economy. The Central Bank of Kenya (CBK), like most other central banks around the world, is entrusted with the responsibility of formulating and implementing monetary policy directed at achieving and maintaining low inflation as one of its two principal objectives; the other being to maintain a sound market-based financial system. This study set to establish the relationship of monetary policy tools and inflation in Kenya. The study employed correlation research design. The study used time series empirical data on the variables to describe and examine the relationships between monetary policy tools and inflation. The study used secondary data on the Consumer Price Index, the measure for inflation, 91-day Treasury bill rate, exchange rate, money supply (M3) and repo rate. The analyses entailed the computation of the various coefficients of correlation denoted as „β‟ in the model to determine the relationship of monetary policy tools in and inflation in Kenya. The study established that inflation and the money supply were positively correlate with each other. The study established that the general level of prices increase with the increase of money supply. The study established the 91 Treasury bill rates have an impact on the level of inflation. This is because the treasury bills rate forms the base of commercial banks interest rates. Therefore an increase in treasury bills leads to an increase in commercial banks base lending rate leading to reduction in liquidity therefore reducing the aggregate demand. Fluctuations of foreign exchange rates were seen to have an effect on the prices. The study recommends that the policy makers need critically evaluate and monitor the levels of money supply in Kenya so as to ensure a stable retail price levels. The study also recommends that the CBK to use 91-day Treasury bills rate in monitoring the level of prices because it has a significant effect on the level of Inflation in Kenya.