The Relationship Between Interest Rate And Inflation Rate In Kenya

Abstract

In this study the relationship between nominal interest and expected inflation in Kenya is investigated. Monthly data for the interbank rate (IBR) and the inflation rate (INF) calculated from CPI for the period between 2003 and 2016 is used. The regression model, Granger causality and ARDL model are the empirical tasks conducted to investigate the relationship. Regression model and Granger causality test show supporting evidence of relationship between the variables. Granger causality Wald test and the ARDL model show that there is causality from INF to IBR and not vice versa. The ARDL(1,0) model fitted show evidence of partial adjustment of IBR for changes in the INF. Hence monetary authorities may, with precaution, use marginal changes in nominal interest to combat inflationary pressure. Nominal Interest rate may not respond fully to inflation expectation.