Effect of Central Bank Independence on inflation in Kenya (1966-2012)
Gitahi, Jane Wangui
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Kenya suffered double digit inflation rates as from 1974 culminating in the highest ever recorded rate of 46 per cent in 1993. High inflation brings with it uncertainties that retard economic growth. As such, it is of paramount importance for a country to put in place mechanisms to maintain low and stable inflation rates. Among the solutions to high inflation rates is conferring independence upon the central bank. This study examined the effect of the independence of the Central Bank of Kenya on inflation in Kenya. It adopted a theoretical framework based on the time inconsistency theory developed by Barro and Gordon (1983). Empirical literature on the relationship between central bank independence and inflation is controversial with some studies showing a strong negative relationship while others find a weak relationship or none at all. This study adopted a correlational research design. Secondary time series data on annual inflation rates, budget deficit, imports, exports and the level of the Gross Domestic Product in Kenya from 1966 to 2012 was used. To contextualize the effect of CBI on inflation, a linear regression model was employed and the OLS estimation technique used to obtain parameter estimates. The results showed a strong negative relationship between CBI and inflation. Thus, increasing the independence of the Central Bank of Kenya leads to low rates of inflation. This is due to the fact that an independent central bank is better able to focus on its goals such as price stability and not defer to the changing needs of the government in place. It also means that monetary policy will dominate over the fiscal policy, which is necessary since fiscal policy changes with every new political government. Different governments have different priorities and as such stability of the Kenyan Shilling will be established through a dominant monetary policy backed by an independent Central Bank of Kenya (CBK).