Stability and Determinants of the Demand for Money in Kenya

Abstract

The structural characteristics of the Kenyan economy and its economy raise the issue of the correct monetary policy for the country, money demand takes a key role in macroeconomics in general and monetary economics in particular, which is why a stable feature of money demand is generally considered necessary for the formulation and conduct of an effective monetary policy. The goal of the study was to investigate the stability of the demand for money in Kenya using recent data due to lack of consensus. A clear understanding of the stability of money demand is important given its consequences for the formulation of monetary policy. The study employed Johansen testing approach for co-integration analysis based on the multiple regressions models and used annual data over the period 1982 to 2014. The purpose of the thesis was to investigate empirically the long-term and short-term determinants of demand for money, and to evaluate how demand for money reacts to inflation, treasury bills, gross domestic product, and commercial bank rates. To achieve these goals, it was hypothesized that the demand for money will make a significant contribution to the implementation of monetary policy by the use of the VECM. Empirical analysis was carried out successfully in R Econometric software; the critical values of ADF were non-stationary at-4.15 at 1%,-3.50 at 5% and-3.18 at 10%, suggesting the possible co-integration of the variables. The study utilizes the long-term correlation between the demand for money and its determinants, the multivariate p-value of the test: < 2.2e-16 acts as a way of cross-checking from a medium to long-term perspective. The results indicate that the demands of the broad monetary aggregates are stable. The existing system in which M2 is considered to be the intermediate target variable of monetary policy may therefore be considered acceptable. It is important that monetary authorities turn their attention to the sectoral implications of money demand for successful monetary and fiscal policies in Kenya. In order to achieve the desired policy goals, policy makers should consider the effect of aggregated real income components on the recognition of different inputs and feedback on them against their policy instruments. This eliminates the bias of the aggregate. Researchers can also take the same path and investigate the role of sector money demand in supporting policy design and management. On the basis of these results, stability and monetary demand determinants suggest that monetary targeting is a viable choice for the conduct of monetary policy for the Central Bank of Kenya.