Monetary Conditions Index for Kenya

Abstract

The purpose of this paper is to construct and test the feasibility of a monetary conditions index (MCI) for Kenya using 2000 – 2011 time series quarterly data. Empirical results confirm the existence of cointegration between aggregate demand (GDP), the real exchange rate, the short-term interest rate and the claims on private sector. The last three variables are key in the monetary transmission mechanism for Kenya. Their relative strengths proceeds from the exchange rate, credit to private sector and the interest rates respectively. On the use of the monetary conditions index as an indicator, results show that it closely mirrors the movements of the interest rates while also closely tracking changes in the exchange rates. This makes its use in Kenya quite realistic since it would not be a radical departure from the use of the Central Bank of Kenya (CBK) rate.