The Effects of Exchange Rate Volatility on the Inflation Rate in Kenya

Abstract

The effect of monetary policy actions affect the general levels of retail prices prevailing in the Country from time to time. Through its monetary policy tools the Government of Kenya is able to control the levels of inflation and moderate negative effects of the exchange rate volatility reported in Kenya. The Central Bank of Kenya (CBK), like most other central banks around the world, was established under Section 231 of the Constitution of Kenya (promulgated on August 27, 2010) to be responsible for formulating monetary policy, promoting price stability, issuing currency and performing other functions conferred on it by an Act of Parliament. It is thus entrusted with the responsibility of formulating and implementing effective policies directed towards achieving and maintaining low inflation rates as one of its two principal objectives; the other being to maintain a sound market-based financial system. Its other secondary objectives include the Formulation and implementation of foreign exchange policy, holding foreign exchange reserves, licensing and supervising authorized dealers, formulation and implementation of such policies as best promote the establishment, regulation and supervision of efficient and effective payment, clearing and settlement systems, act as banker and adviser to, and fiscal agent of the Kenyan government and lastly, to issue currency notes and coin. This study employs correlational research design as well as regression analysis. The study used time series empirical data on the variables to describe and examine the effects of the exchange rate volatility on the rate of inflation in Kenya by establishing correlation coefficients between the inflation and the monetary policy tools, namely, the exchange rates and the T-bill rate prevailing over the entire study period. The study used secondary data on the Consumer Price Index for inflation, 91-day Treasury bill rate, as well as for the exchange rate. The analyses entailed the computation of the various coefficients of correlation denoted as ‘β’ in the model, the coefficient of determination as well as the Anova test, to determine the effects of the exchange rate volatility on the rate of Inflation in Kenya.