Assessing the effectiveness of monetary policy in Kenya: Evidence from a macroeconomic model

- We use a macroeconometric model to analyze monetary policy effectiveness in Kenya.
- Policy transmission to the real economy and impact on overall inflation are minimal.
- However the interest rate channel has relatively higher impact on inflation.
- Banking lending channel has relatively higher impact on aggregate demand.
- Monetary policy impact depends on the effectiveness of the transmission mechanisms.

This paper examines the effectiveness of monetary policy in Kenya based on policy simulations from a structural macroeconometric model. The analysis is conducted using the policy rate, i.e. the central bank rate (CBR) and the cash reserve ratio (CRR) with respect to the interest rate and bank lending channels, respectively. The results indicate that whereas a change in the policy rate is effective in influencing short term rates, the long term lending rates respond marginally. Consequently, the transmission to the real economy and the overall impact on inflation is minimal. However, a change in CBR has a comparatively higher impact on inflation while a change in CRR has a relatively larger impact on aggregate demand. Enhancing the effectiveness of the CBR and strengthening of the interest rate channel have the potential of anchoring inflation expectations and boosting the effectiveness of monetary policy in Kenya.