An analysis on the impact of the asset price .channel of monetary policy transmission mechanism on stock prices in Kenya

Abstract

The purpose of this paper was to find out the effectiveness of the asset price channel in Kenya. The methodology involved using a Vector Autoregression (VAR) where the study used contemporaneous shocks to short term interest rates to get the effect on the asset prices .The variables used in this study were the real GDP, inflation as derived from the . Consumer Price Index (CPI), the NSE return, repo rate, interbank rate and T-Bill rate . . The study established that the asset price channel of monetary transmission mechanism in Kenya is not effective. This was shown by the effects of the proxies of the asset price by ,.' shocks to the short term interest rates. Second, instability in the stock market prices , creates instability in GDP and inflation. The results indicate that most of the variation in stock prices is explained by changes in the interbank rate. Interbank rate explains 'over 25 percent of the variance in the stock prices in the initial periods progressing to over 32 percent after four quarters. The money supply and inflation also explain some insignificant variation in stock prices and their proportionate explanations increase as the quarter progresses. GDP explain very little of the variations in stock prices. However, the, substantial part of the total variance of the stock prices comes on stock prices itself. These results imply that in , designing monetary policy, the central bank cannot completely ignore information coming from the stock market since this information can ' 'be used to predict the direction of the business cycle.