The long run relationship between interest rates and inflation in Kenya
This thesis investigates the relationship between expected inflation and nominal interest rates in Kenya and the extent to which the Fisher effect hypothesis holds. The hypothesis, proposed by Fisher (1930), which stipulates that the nominal rate of interest reflect movements in the expected rate of inflation has been the subject of much empirical research in many industrialised countries. This wealth of literature can be attributed to various factors including the pivotal role that the nominal rate of interest and, perhaps more importantly, the real rate of interest plays in the economy. Secondary data was collected from the published reports for the period of thirteen years between 1999-2011. Regression analysis was used in this in this study because it is widely used for prediction and forecasting. The study derived the nominal interest rate from the T bill rate, inflation rate from CPI and finally the actual real rate from GDP. Computed Real interest rates and actual Real interest rates were compared over a period of 13 years (1999 to 2011) to determine if the fisher hypothesis holds in Kenyan Economy. The findings and analysis support to the existence of partial fisher effect in Kenya because both interest rates and inflation rate do not move with one on-one over the period under study. The average of interest rate obtained from expected rate of interest on facilities has a long run relationship with inflation rate, but as the results showed, this relation is very weak, and it can be ignored. The most likely explanation for this weak relationship is because expected rate of interest on facilities are not formed by market forces, but are artificially determined by monetary authorities as part of the monetary policy framework.