The Effect of Lending Interest Rate on Economic Growth in Kenya

Abstract

According to economic theory the base rate is set by the banks to determine the interest rate and in Kenya it’s the CBK rate. Darrat and Dickens (1999), argue that interest rate environment is important in the performance and the returns of any given investment. The CBK through the monetary policy and the bank rate has a very strong bearing on the performance of any sectors. Following interest rate liberalization, interest rates have fluctuated to respond to changes in demand and supply of loanable funds in the financial market. Various studies have been conducted but they have been sectoral in nature, however no known study that has dealt on the effects of interest rate on the general economic growth has been done. This study therefore seeks to fill the knowledge gap that currently exists. It aimed to establish the effect of lending interest rate on economic growth in Kenya and the empirical evidences that help answer the research objective. I collected data from the KNBS and from the Central bank of Kenya for a 10 year period starting 2003 to 2012 and the same was regressed quarterly to help answer the research question. The study established that there is a negative relationship between interest rate and the economic growth. Interest rate was not studied in isolation but there were other variables which were also studied i.e budget deficit, inflation rate, exchange rate and gross investment whose effect to the economic growth was also established. Since lending interest has a strong bearing on economic growth, it’s imperative that the government puts policies in place to check the interest rate. It’s the same thing for the other variables which were also studied namely; budget deficit, inflation rate, exchange rate and gross investment.