Effects of Monetary Policy Changes on Credit and Economic Growth in Kenya

Abstract

Several empirical studies have confirmed that there is a positive relationship between credit growth and economic growth. The Central Bank of Kenya (CBK) has in the past attempted to use monetary policy to influence the direction of credit growth with the aim of improving economic growth in Kenya. The objective of this study therefore is to determine whether there is a relationship between credit growth and economic growth, whether an increase in credit does in fact improve economic growth in Kenya and whether a reduction in the CBR reduces the commercial bank lending rates and thereby increasing the amount of credit available in Kenya. Using data between 1971 and 2008 and Vector Autoregression (VAR) model, it is found that even though credit growth deviates so much from the long run trend, it still traces economic growth and therefore using monetary policy to target credit growth with the aim of irifluencing the direction of economic growth is still beneficial in the long run. The results also show that lending rates reduces following an expansionary monetary policy. This is consistent with expectations but the lending rates seem to respond a bit sluggishly. The findings further show that loans and advances will increase if there is a positive shock in the lending rates. This finding is contrary to expectations. This positive impact could imply that loan demand in Kenya is inelastic. The findings further show that, other than own shocks, the variations in credit growth mainly come from the changes in lending rates and GDP. More emphasis therefore need to be put in these two variables to avoid too violent volatility of credit growth.