Financial sector and economic growth in Kenya: an empirical analysis
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Since efficient banking systems and stable and strong stock market tend to contribute to higher economic growth in any country, studies of this nature are very important for policy makers, industry leaders and others who are reliant on these sectors. This study aims at filling a gap in this regard as it examines the effect of capital and money markets on economic growth. Time series data for Kenya for the period 1968 - 2008 was analysed. Then, the study employed a parsimonious Autoregressive Distributed Lag Error Correction Model and using the NeweyWest standard errors, the study found that with respect to the bank-based model, money supply as a percentage of GDP and domestic credit as a percentage of GDP have significant impact on the level of GDP prevailing within the economy. Similarly, with respect to the stock marketbased model, only the volume of stock traded as a percentage of GDP has a statistically significant impact on GDP. Finally, the study performed the Granger Causality test with results showing that stock market turnover as a percentage of GDP, market capitalization as a percentage of GDP and bank deposit as a percentage of GDP have no effect on the level of real GDP prevailing within the economy. On the other hand, it was found that money supply as a percentage of GDP, domestic credit as a percentage of GDP and the volume of stock traded as a percentage of GDP each individually Granger causes the level of real GDP prevailing within the economy. These results suggest that monetary policy should be exercised with caution so as to avoid inflationary spiral within the economy. Given that the' stock of money circulating with the economy has significance effect on the economy, the monetary authorities should not increase the money supply unnecessarily but rather allow the quantity of money circulating within the economy to grow in line with the level of economic activities.