Modeling Interest Rate on Economic growth of Kenya between 1970 and 2018

Abstract

The high-interest rate has been a problem in Sub-Saharan Africa, specifically Kenya, for a long time. The high-interest rates have prevented the growth of companies since they shun away from borrowing capital to grow their business. Most governments have used interest rate capping as a ceiling tool to regulate and control the excessive interest rate by financial institutions. During interest rate capping periods, the Kenyan government controls the official interest rate for banks operating within their borders, hence reducing banks’ appetite to deposit, which may reduce money in circulation, thus reducing demand and supply. Developing countries, like Kenya, tend to have a negative real interest rate resulting from administrative controls on nominal interest rates and burdensome regulations of their financial markets. Existing studies that have indirectly linked interest rates and economic growth are from Latin America and Asia. Furthermore, existing studies have adopted inappropriate mathematical tools to relate to interest rates and economic growth. The study sort to the model interest rate on the economic growth of Kenya between 1970 and 2018. The study specifically 1) Model interest rate capping and economic growth of Kenya. 2) Model mathematical relationship between the lending interest rate and economic growth of Kenya. 3) Estimate the mathematical relationship between the deposit interest rate and economic growth of Kenya and 4) Approximate mathematical relationship between the real interest rate and economic growth of Kenya. Data analysis based on SPSS, Matlab, Excel and R for secondary data central bank of Kenya website indicated that only the real interest rate has a positive correlation with economic growth. Regression analysis also suggests that only the real interest rate positively affects economic growth. Descriptive statistics indicated that the capping interest rate has the highest standard error mean (1:1536), and economic growth had the least standard error mean value (0:5936). The models formulated also show capping interest rates and lending interest rates have negative relationships with economic growth. The relationship between the deposit interest rate and economic growth is based on regression equation and deposit interest rate is estimated based on an optimization problem. The optimization problem solution indicates that the optimal deposit interest rate is 0:06039. The real interest rate model formulated also shows that a positive relationship with economic growth. The study concludes that the interest rate is significant in economic growth. The study suggests a future segmented short- and long-term effects of interest rate indicators on economic growth.