An analysis of the relevance of the monetary approach to Kenya's balance of payments (1969-2002)
Balance of payments deficits have been a common phenomenon in the Kenyan Economy from the 1960s. The government has over the years enacted various policy measures aimed at remedying the situation, however the balance of payments situation does not seem to have improved despite these policy measures. This study examines the relevance of the monetary approach to the balance of payments in Kenya using annual data covering the period 1969 to 2002. The monetary approach is one of five approaches to the balance of payments. The others are the Keynesian, elasticity, absorption and the portfolio balance approaches. According to the monetary approach, the balance of payments is essentially a monetary phenomenon. To carry out the study data, from the International Financial Statistics yearbooks and the May 2003 CDROM is used. The data is tested for unit root tests and co integration, among the variables established and thus a vector error correction (VEC) model is estimated. The results of the VEC estimation indicate that BOP is significantly affected by its own second and third lags, the first and second lags of exchange rate and the first lag of prices. Granger causality tests show no causality between balance of payments and the other five variables. However impulse response analysis indicates five years as the period within which balance of payments responds to innovations. Domestic credit and interest rate are the two important variables affecting Kenya's balance of payments. Exchange rate and prices are also significant. The study finds the monetary approach relevant in managing Kenya's balance of payments.