Journal of Applied Finance & Banking

The Effect of Monetary Policy on Private Sector Investment in Kenya

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  • Abstract

    The study explores the relationship between monetary policy and private sector investment in Kenya by tracing the effects of monetary policy through the transmission mechanism to explain how investment responded to changes in monetary. Several studies have offered a means to understand the manner in which monetary policy actions affect investment, prominent among them are the Classical school, Majumder (2007), the Keynesian, Barro (1997), and recently the Credit Channel Approach, Kahn (2010), Bernanke and Gertler (1995). The study utilises quarterly macroeconomic data from 1996 to 2009 and the methodology draws upon unit roots and cointegration testing using a vector error correction model to explore the dynamic relationship of short run and long run effects of the variables due to an exogenous shock. The variables are stationary in first differences and using ordinary least squares the estimated long run relationship is: LRPSC = 1.84 - 0.54LRGDD + 0.62LRGDS + 0.75LRMS - 0.04LTBILL .  Implying that government domestic debt and Treasury bill rate are inversely related to private sector investment, while money supply and domestic savings have positive relationship with private sector investment consistent with the IS-LM model. Based on the empirical results the study suggests that tightening of monetary policy by -1 percent has the effect of reducing investment by -2.63 while the opposite loose monetary policy tends to increase investment by 2.63.The error correction term (ECT) of -0.55 is negatively signed indicating a move back to equilibrium suggesting that following an exogenous shock, 55 percent of the disequilibrium is corrected after one quarter.