Monetary policy effectiveness - the role of financial frictions on the effectiveness of the Kenyan Monetary Polilcy

Abstract

This paper examines the role of credit market frictions on the effectiveness of the Kenyan monitory policy .Following from the credit channel theory, of particular interest is the credit channel of the Kenyan monitory policy and its interaction with financial frictions. I test the theoretical prediction of the theory that monetary policy transmission mechanism through the credit channel is more effective and stronger in countries and periods of high levels of financial frictions, hence with low levels of financial frictions, the monetary policy transmission mechanism is less effective. SV AR impulse responses of output and prices are analyzed with respect to monetary policy shock, where both the credit and exchange rate channels of monetary policy are found to be present. A regression analysis between proxy of financial friction (interest rate spread) and the maximum amplitude of output and price responses depicts a positive and statistically significant relation between financial frictions and monetary policy effectiveness after controlling for factors such as financial development and firm size. Results from this research will help inform policy decisions of the CBK through the MPC and CRB.