Impact of fiscal and monetary policy on stock market performance in Kenya

Abstract

Given the important role of the stock market to an economy, this study aims to explore the impact of fiscal and monetary policy on the stock market in Kenya. The study uses Structural Vector Error Correction model (VECM) while controlling for GDP and average lending rates (market interest rates). M2 is used as a proxy for monetary policy, government expenditure for fiscal policy and data on NSE-20 for stock prices in Kenya. Quarterly data spanning from 1998 to 2015 was used. Despite the results revealing that monetary policy, fiscal policy and the combined effect of the two are not significant in explaining stock price movements for the period under study, the impulse response function and error variance decomposition results suggest that the stock market variable does respond to a positive shock applied to the monetary and fiscal policy variables. However as the stock market in Kenya continues to develop, the fiscal and monetary policy variables may become significant and may have a sizeable influence on the movement of stock prices. Therefore there may be a need for coordination.