Money supply, GDP and price level causality and long-run relationship in Kenya : an empirical analysis

Abstract

This research study is mainly based on the fundamental relationship between money supply, prices and the gross domestic product in Kenya. The quarterly time series data of real Gross Domestic Product (GDP), money supplies (MS) and consumer price index (CPI) for the period 2000-2016 were used. The stationary properties of the data series were investigated using the Augmented Dickey Fuller method. To investigate on the existence of a long run relationship among these macroeconomic variables, Co-integration analysis has been employed. To explore the short run direction of causality between GDP, CPI and MS, the Granger causality test has been applied. The direction of causation between CPI and broad money variable M3 was found to be unidirectional from CPI to M3 without any feedback. Regarding the causal relationship between GDP and money supply, the analysis suggests that the causation runs from M1 to GDP, but GDP does not cause M1 The Co-integration analysis established a co-integrating relationship thus suggesting that there is a long run relationship existing among the three macro-economic variables.