Interaction of fiscal and monetary policies and the effects on share prices at the Nairobi securities exchange
Wamwere, Joseph Muigai
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The stock market plays a key role in the development of an economy. The market enhances savings and efficient allocation of scarce resources. The share prices have been volatile at the Nairobi Securities Exchange. This volatility hurts predictability of share prices and investors hardly know what to expect and when. The fiscal and monetary policies have been found to have a role in performance of share prices independently. However, the effect of their interaction on • share prices has been ignored in earlier studies. This study seeks to evaluate .the effects of the interaction of fiscal and monetary policies through interest rate, inflation rate, and exchange rate, on share prices at the Nairobi Securities Exchange. To achieve the specific objectives, the share prices were regressed on estimated values of inflation rate, exchange rate, and interest rate under Two-Stage Least Square Method. The data used in the study included quarterly time series data for money supply, current account deficit, public debt, government deficit, interest rate, exchange rate, inflation, and SE20 from 2006 and 2014 which were collected from Central Bank of Kenya and Nairobi Securities Exchange. An interactive variable representing interaction of fiscal and monetary policies was introduced in the inflation rate, exchange rate, and interest rate equations. It was computed as a product of money supply and budget deficit. Inflation rate was estimated using money supply, government deficit, and interactive variable. Money supply, government deficit, and interactive variable had significant coefficients. Exchange rate was estimated using money supply, current account deficit, public debt, budget deficit and interactive variables as the independent variables. The coefficients for money supply, current account • deficit, budget deficit, and interactive variable were statistically significant.: Interest rate was estimated as a function of money supply, public debt, government deficit, and interactive variable. The coefficients of money supply, public debt, and interactive variable were statistically significant. In the Two-Stage Least Square model, fitted inflation rate, fitted exchange rate, and fitted interest rate had coefficients that were statistically significant making the variables to be important determinants of share prices. This meant that the coefficients were significant in the model. The interaction of fiscal and monetary policies through inflation rate channel and exchange rate channel had a positive effect on share prices. The interaction of fiscal and monetary policies through interest rate had negative effect on share prices.