Interaction of fiscal and monetary policies and the effects on share prices at the Nairobi securities exchange
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Date
2015-12
Authors
Wamwere, Joseph Muigai
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Abstract
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.
Description
A research project submitted to the school of economics in partial fulfillment of the requirements for the award of the degree of Master of economics (finance) of Kenyatta University.