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A VAR Analysis of Kenya's Monetary Policy Transmission Mechanism: How Does the Central Bank's Repo Rate Affect the Economy?

This paper examines the impact of a monetary policy shock on output, prices, and the nominal effective exchange rate for Kenya using data during 1997-2005. Based on techniques commonly used in the vector autoregression literature, the main results suggest that an exogenous increase in the short-term interest rate tends to be followed by a decline in prices and appreciation in the nominal exchange rate, but has insignificant impact on output. Moreover, the paper finds that variations in the short-term interest rate account for significant fluctuations in the nominal exchange rate and prices, while accounting little for output fluctuations.