Monetary Policy and Asset Prices in Kenya: Does the Central Bank Respond to Asset Prices?

Abstract

The intricacy that defines how monetary policy relates with asset prices has garnered interest in many studies due to the importance of the position held by asset prices in influencing the financial stability of economies across the world. This research studies how asset prices (variation in stock prices) shape the central bank’s monetary decisions in Kenya. Drastic shifts in the prices of assets have impacted different sectors of economies across the globe. As a result, policy makers in monetary authorities across the world have debated on how to treat asset prices as they implement monetary policy for their economies. A change in stock prices variable is added to a Taylor rule that is forward looking to study how asset prices have affected monetary policy decisions in Kenya (Clarida et al., 1998). The study employs quarterly data ranging from initial quarter 2000 to initial quarter 2019 and uses the Generalized Method of Moments (GMM) as a method of estimation. The results show that the parameter estimate of the change in stocks price variable is positive and statistically significant. This means that the monetary authority tightens monetary policy in response to an ascent in the change in stock prices. Additionally, we find significant positive parameter estimates for output gap and interbank rate while the coefficient of inflation gap lacks statistical significance. The study also finds that the adjustment of the central bank to target interest rates is approximately 0.37 basis points