## _wp06300

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---

### I. INTRODUCTION
- Purpose: Analyze the transmission mechanism of monetary policy in Kenya using VAR techniques.
- Key research questions:
  - How does a monetary policy shock—defined as a temporary and exogenous rise in the Central Bank Kenya’s (CBK) Repurchase Agreement (REPO) rate—affect real output, prices, and the nominal effective exchange rate?
  - How much do variations in the short-term interest rate account for fluctuations in output, prices, and the nominal effective exchange rate?
- Motivation: Address gaps in analytical work on Kenya’s transmission mechanism to inform design, management, and implementation of monetary policy and shed light on episodes such as the double-digit inflation in Kenya between September 2004 and June 2005.

### Empirical approach and context
- Methodology:
  - Vector autoregression (VAR) framework following identification of monetary policy shocks as temporary and exogenous rises in short-term interest rates (Sims (1980) tradition; examples cited: Christiano, Eichenbaum, and Evans (2000); Kim and Roubini (2000); Peersman and Smets (2003)).
- Sample and data:
  - Monthly data during 1997–2005.
  - Note: "The sample is truncated at 1997 because the CBK embarked on the open market operations using repurchase agreements to manage daily liquidity since end-1996. In addition, prior to the mid-1990s, Kenya undertook a host of drastic financial reforms, such as an exchange rate regime change, liberalization of trade and the capital account, as well as the removal of interest rate controls. Estimating the model using longer time series may capture extensive structural breaks, thereby rendering technical problems for the VARs."

### Key empirical findings
- Effects of a temporary exogenous rise in the CBK’s REPO rate:
  - Followed by a decline in prices and appreciation in the nominal exchange rate, with effects culminating 9–12 months after the incipient shock.
  - Impact on output appears to be sluggish and small.
- Quantitative contributions of short-term interest rate variations to macroeconomic fluctuations:
  - Account for around one-third of the fluctuations in prices.
  - Account for around one-half of the fluctuations in the nominal exchange rate.
  - Account for around 10 percent of the output variation.
- Interpretation:
  - Evidence of a weak transmission mechanism from monetary policy stance to real variables, likely reflecting structural problems in the financial market, including inadequate financial infrastructure and weak legal framework.
  - Stronger link between monetary policy and nominal variables.
  - Plausible transmission channel: a rise in interest rates associated with a tight monetary stance makes domestic assets more profitable vis-à-vis foreign assets, resulting in capital inflows and appreciating pressure on the exchange rate; exchange rate appreciation makes imports cheaper, thereby easing inflation.

### II. INSTITUTIONAL BACKGROUND AND STYLIZED FACTS
- Objective of Monetary Policy:
  - The Central Bank of Kenya Act: "the principal object of the Bank shall be to formulate and implement monetary policy directed to achieving and maintaining stability in the general level of prices."
  - Additional statutory objective: "the Bank shall foster the liquidity, solvency, and proper functioning of a stable market-based financial system."
- Targets:
  - Operational targets and intermediate target:
    - Broad money (M3X) serves as the intermediate target.
    - Reserve money (bank deposits at CBK and currency outside bank) serves as the operating target.
- Monetary instruments used by CBK:
  - Open Market Operations (OMO):
    - Main active monetary instrument used to manage liquidity.
    - Conducted through sale and purchase of government securities using repurchase agreement (REPO) with commercial banks.
    - Auctions—where commercial banks bid for rates, which the CBK accepts or rejects—are held daily.
  - Reserve Requirements:
    - Commercial banks are required to maintain a daily proportion of their liabilities in cash—currently 6 percent—at the CBK.
    - Not an actively used monetary policy instrument.
  - Other Instruments:
    - Rediscount Facilities and Lender of Last Resort Facility, which "have not been recently used as the key tools for implementing monetary policy."

### Stylized facts (January 1998–June 2005)
- Interest rates, money, exchange rate, inflation, and output:
  - Nominal short-term interest rates were mostly double-digit prior to the second quarter of 2002, with a few exceptions of brief episodes of interest rates falling slightly short of 10 percent.
  - Starting around the second and third quarters of 2002, looser monetary policy stance came into force, with nominal short-term interest rates beginning to fall below 10 percent and continuing to fall to less than 1 percent in 2004, resulting in a prolonged period of negative real interest rates since the first quarter of 2003.
  - Reserve money grew at negative rates during some prolonged periods and broad money growing rather mildly prior to mid-2002; accelerated growth rates for the money supply corresponded with the loosening of monetary policy starting in the second and third quarters of 2002.
  - The decrease in the reserve requirement from 10 percent to 6 percent in mid-2003 further fueled the growth of money.
- Relationships:
  - Low interest rates tend to be followed by a depreciation of the Kenyan shilling:
    - NEER movement seems to have followed the short-term interest rate with a lag, with an appreciation following an increase in nominal interest rates and vice versa.
    - The proportion of foreign-currency-denominated deposits in broad money tend to rise with a decline of interest rates; when interest rates were high in the late 1990s, the shilling was strong while a weak currency seems to have been concurrent with a low interest rate environment recently.
  - Low short-term interest rates tend to be followed by high inflation:
    - Inflation in Kenya, amid high interest rates, was mild during 1998-2002, except a few brief episode of inflation slightly above 10 percent in 2000 owing to a severe drought.
    - Following the loosening of monetary stance starting in mid-2002, inflation starting from 2003, amid very low interest rates, was on average considerably higher than the previous period.
  - Short-term interest rates do not seem to bear a significant relationship with real output:
    - The highly negative real interest rates associated with the sharp monetary expansion since mid-2003 seemed to have contributed to robust credit growth in 2004, yet the very high short-term interest rate environment in 1998 was also accompanied robust credit growth to the private sector.
    - Low-interest rate environment coincided with strong growth in real non-agricultural output in 2004, while similar environment in 2003 coexisted with a negative growth in real investment.
    - Historical evidence (1983–2004) indicates high short-term interest rates have not necessarily been followed by stagnation, while low short-term interest rates have not necessarily stimulated the economy.

### A VAR model for Kenya: model setup
- Structural form:
  - ttt XLCYLGε+=)()(, where G(L) is an n×n matrix polynomial, C(L) is k×n matrix polynomial, tY is 1×n vector of endogenous Kenyan variables, tX is 1×k vector of exogenous foreign variables, tε is 1×n vector of structural disturbances with Λ=)var( tε and Λ diagonal.
- Reduced-form:
  - tttt XLBYLAYμ++=)()(, with )(LA and )(LB matrix polynomials, tμ reduced-form disturbances with Σ=)var( tμ.
- Relation between structural and reduced-form:
  - )()(LHFLG += ; )()(1 LHFLA − −= and )()(1 LCFLB − =.
  - Errors: tt Fεμ 1− = or tt Fμε =, implying '11−− Λ=ΣFF.
- Identification:
  - Normalization of diagonal elements of F to unity; need 2/)1(−×nn additional restrictions motivated by economic theory.
- Exogenous vector tX:
  - [] FedOilCommX t =' where Comm = commodity price index based on Kenya’s main exports, Oil = world fuel commodity price index, Fed = U.S. Federal Fund’s rate.
- Endogenous vector tY:
  - [] tttttt NEERSMCPIGDPY=' with real GDP, CPI, money stock (M), short-term interest rate (S), and NEER.
- Benchmark choices:
  - Money stock (M) = M3X.
  - Short-term interest rate (S) = REPO rate.
- Data and estimation specifics:
  - VARs estimated in levels using monthly data between 1997 and 2005.
  - All variables seasonally-adjusted and expressed in logarithms, except interest rates in percentage terms.
  - Standard information criteria select lag length = 5.
  - A sequential Chow test suggests no evidence of structural breaks at the 5 percent confidence level.
  - Monthly GDP obtained by interpolating annual GDP based on monthly production data of key sectors.

### Identification schemes
- Identification Scheme One: Recursive VAR (Cholesky)
  - Ordering: GDP, CPI, M, S, NEER.
  - Assumes CPI has no immediate effects on GDP; M has no immediate effect on CPI; S has no immediate effect on M; NEER has no immediate effect on monetary policy.
- Identification Scheme Two: Non-Recursive Structural VAR
  - Relaxed contemporaneous restrictions following Sims and Zha (1998) and Kim and Roubini (2000).
  - Interpreted system:
    - First two equations: sluggish response of real GDP and prices to nominal shocks.
    - Third equation: short-run money demand responding contemporaneously to output, prices, and short-term interest rates.
    - Fourth equation: monetary policy reaction function responding contemporaneously to money demand and exchange rate, not immediately to contemporaneous output and price shocks.
    - Fifth equation: nominal exchange rate responds immediately to all other variables.

### Estimation results (benchmark model, January 1997–June 2005)
- Impulse responses to a one-standard deviation monetary policy shock (an exogenous, unexpected, temporary rise in the REPO rate at t=0) with 95 percent confidence bands (bootstrapped with 500 replications):
  - Output:
    - The effect on output appears to be insignificant; impact is not statistically distinguishable from zero over the next 36 months.
  - Prices:
    - Monetary shock has a significant and persistent impact on prices.
    - An unexpected and temporary rise in the short-term interest rate is followed by a decline in prices, with the effect peaking at 9 to 12 months after the shock.
  - NEER:
    - NEER responds strongly to a monetary shock.
    - An unexpected and temporary rise in the short-term interest rate tends to be followed by nominal appreciation, with the impact culminating 9-12 months after the shock.
- Forecast error variance decompositions:
  - Under both recursive and structural VARs:
    - Monetary shock accounts for one third of the fluctuations in prices.
    - Monetary shock accounts for a half of the fluctuations in the nominal exchange rate.
    - Around a tenth of the fluctuations in output can be attributed to the monetary shock.
- Non-agricultural output:
  - Substituting non-agricultural output for GDP yields similar results: monetary policy has little impact on non-agricultural output.
- Robustness:
  - Results are qualitatively robust to identification scheme (recursive vs structural), alternative definitions of monetary policy shock (rise in interbank rate instead of REPO), and using reserve money instead of M3X as the money variable.
  - Varying the sample start year (1998, 1999, 2000 vs benchmark 1997) yields broadly similar impulse responses.

### Economic interpretation and policy implications
- Economic interpretation:
  - Monetary policy primarily affects nominal variables:
    - Tightening (rise in short-term interest rates) tends to appreciate the nominal exchange rate, likely reflecting capital mobility induced by interest rate differentials.
    - Exchange rate appreciation makes imports cheaper, decreasing the overall price level and the rate of inflation.
  - Weak transmission to real sector:
    - Monetary policy seems to have little impact on real output.
    - Plausible explanation: structural weaknesses in the financial sector hamper transmission (weak legal framework, poor governance, insufficient infrastructure), leading to high interest rate spreads, inadequate financial intermediation, and heightened risks.
- Policy implications:
  - Given the weak link between output and monetary stance amid a strong link between price stability and monetary stance, there seems little scope for balancing output stabilization and price stability.
  - Near-term overriding objective of monetary policy should be to maintain low inflation.
  - Structural reforms recommended to improve monetary transmission:
    - Improving governance of the Central Bank of Kenya (CBK).
    - Strengthening the regulatory framework.
    - Enhancing the legal framework.

### Caveats, data limitations, and robustness analysis
- Caveats and data limitations:
  - Sample period is relatively short; findings may pertain to idiosyncratic developments during the sample period and may not generalize to future behavior.
  - Data quality concerns, particularly output data:
    - Large size of the informal sector may cause national accounts statistics to miss important activities influenced by monetary policy.
- Robustness analysis (appendix highlights):
  - Stability of VAR:
    - Recursive Chow tests (p-values computed by bootstrapping) suggest the benchmark VAR is stable over the sample period; p-values are significantly higher than 5 percent so the null of stability cannot be rejected.
  - Stability of impulse responses over time:
    - Impulse responses using shorter sample periods (starting in 1998, 1999, and 2000) are broadly similar to the benchmark case.
  - Alternative variables:
    - Using the interbank rate as the monetary policy instrument produces similar impulse responses.
    - Using reserve money (CBK’s operating target) instead of M3X (CBK’s intermediate target) yields similar conclusions.

### References (selected from the source)
- Aron, J., and J. Muellbauer, 2002. “Interest rate effects on output: evidence from a GDP forecasting model for South Africa.” IMF Staff Papers 49 (November, IMF Annual Research Conference): 185-213.
- Berdin, Don, and Gerard O’Reilly, 2004, “An Analysis of the Transmission Mechanism of Monetary Policy in Ireland,” Applied Economics, Vol 35, pp. 49-58.
- Brischetto, Andrea, and Graham Voss, 1999, “A Structural Vector Autoregression Model of Monetary Policy in Australia, “ Reserve Bank of Australia, Research Discussion Paper, 1999-11.
- Peersman, Gert and Frank Smets, 2003, “The Monetary Transmission Mechanism in the Euro Area: Evidence from VAR Analysis,” Monetary Transmission Mechanism in the Euro Area, Cambridge University Press.
- Christiano, L., M. Eichenbaum, and C. Evans, 2000, “Monetary Policy Shocks: What Have We Learned and to What End?” in Handbook of Macroeconomics (Amsterdam: North Holland).
- Kim, Soyoung, and Nouriel Roubini, 2000, “Exchange Rate Anomalies in the Industrial Countries: A Solution with a Structural VAR Approach,” Journal of Monetary Economics, pp. 561-568.
- Sims, Christopher, 1980, “Macroeconomics and Reality,” Econometrica, 48(1), 1-48

*IMF staff estimates (January 1997–June 2005, figures and tables as presented in the source).*

### References..............................................................................................................

### _wp06300 - References

### I. INTRODUCTION
- Purpose: Analyze the transmission mechanism of monetary policy in Kenya using VAR techniques.
- Key research questions:
  - How does a monetary policy shock—defined as a temporary and exogenous rise in the Central Bank Kenya’s (CBK) Repurchase Agreement (REPO) rate—affect real output, prices, and the nominal effective exchange rate?
  - How much do variations in the short-term interest rate account for fluctuations in output, prices, and the nominal effective exchange rate?
- Motivation: Address gaps in analytical work on Kenya’s transmission mechanism to inform design, management, and implementation of monetary policy and shed light on episodes such as the double-digit inflation in Kenya between September 2004 and June 2005.

### Empirical approach and context
- Methodology: Vector autoregression (VAR) framework following the strand of literature that identifies monetary policy shocks as temporary and exogenous rises in short-term interest rates (Sims (1980) tradition; examples cited: Christiano, Eichenbaum, and Evans (2000); Kim and Roubini (2000); Peersman and Smets (2003)).
- Sample and data: Monthly data during 1997–2005.
  - Note on sample truncation: "The sample is truncated at 1997 because the CBK embarked on the open market operations using repurchase agreements to manage daily liquidity since end-1996. In addition, prior to the mid-1990s, Kenya undertook a host of drastic financial reforms, such as an exchange rate regime change, liberalization of trade and the capital account, as well as the removal of interest rate controls. Estimating the model using longer time series may capture extensive structural breaks, thereby rendering technical problems for the VARs."

### Key empirical findings
- Effects of a temporary exogenous rise in the CBK’s REPO rate:
  - Followed by a decline in prices and appreciation in the nominal exchange rate, with effects culminating 9–12 months after the incipient shock.
  - Impact on output appears to be sluggish and small.
- Quantitative contributions of short-term interest rate variations to macroeconomic fluctuations:
  - Account for around one-third of the fluctuations in prices.
  - Account for around one-half of the fluctuations in the nominal exchange rate.
  - Account for around 10 percent of the output variation.
- Interpretation:
  - Evidence of a weak transmission mechanism from monetary policy stance to real variables, likely reflecting structural problems in the financial market, including inadequate financial infrastructure and weak legal framework.
  - Stronger link between monetary policy and nominal variables.
  - Plausible transmission channel: a rise in interest rates associated with a tight monetary stance makes domestic assets more profitable vis-à-vis foreign assets, resulting in capital inflows and appreciating pressure on the exchange rate; exchange rate appreciation makes imports cheaper, thereby easing inflation.

### II. INSTITUTIONAL BACKGROUND AND STYLIZED FACTS
- Objective of Monetary Policy:
  - The Central Bank of Kenya Act: "the principal object of the Bank shall be to formulate and implement monetary policy directed to achieving and maintaining stability in the general level of prices."
  - Additional statutory objective: "the Bank shall foster the liquidity, solvency, and proper functioning of a stable market-based financial system."
- Operational targets and intermediate target:
  - Broad money (M3X) serves as the intermediate target.
  - Reserve money (bank deposits at CBK and currency outside bank) serves as the operating target.

### Monetary instruments used by CBK
- Open Market Operations (OMO):
  - Main active monetary instrument used to manage liquidity.
  - Conducted through sale and purchase of government securities using repurchase agreement (REPO) with commercial banks.
  - Auctions—where commercial banks bid for rates, which the CBK accepts or rejects—are held daily.
- Reserve Requirements:
  - Commercial banks are required to maintain a daily proportion of their liabilities in cash—currently 6 percent—at the CBK.
  - Not an actively used monetary policy instrument.
- Other Instruments:
  - Rediscount Facilities and Lender of Last Resort Facility, which "have not been recently used as the key tools for implementing monetary policy."

### Stylized facts (major developments during January 1998–June 2005)
- The paper summarizes four stylized facts about the monetary sector in Kenya during January 1998–June 2005.
- Stylized fact noted in excerpt:
  - "Monetary stance began to loosen since mid-2002—Tight monetary stance appears to have been one of the dominant features for the Kenyan economy between 1998 and" (text truncated in source).

*Source: _wp06300 - References (extracted content from the provided PDF chapter/section).*

### 2002. As shown in Figure 1, nominal short-term interest rates were mostly double-

### 2002. As shown in Figure 1, nominal short-term interest rates were mostly double-

### Stylized facts: interest rates, money, exchange rate, inflation, and output
- Nominal short-term interest rates were mostly double-digit prior to the second quarter of 2002, with a few exceptions of brief episodes of interest rates falling slightly short of 10 percent.
- Starting around the second and third quarters of 2002, looser monetary policy stance came into force, with nominal short-term interest rates beginning to fall below 10 percent and continuing to fall to less than 1 percent in 2004, resulting in a prolonged period of negative real interest rates since the first quarter of 2003.
- Reserve money grew at negative rates during some prolonged periods and broad money growing rather mildly prior to mid-2002; accelerated growth rates for the money supply corresponded with the loosening of monetary policy starting in the second and third quarters of 2002.
- The decrease in the reserve requirement from 10 percent to 6 percent in mid-2003 further fueled the growth of money.

- Low interest rates tend to be followed by a depreciation of the Kenyan shilling:
  - The movement of the nominal effective exchange rate (NEER) seems to have followed the short-term interest rate with a lag, with an appreciation following an increase in nominal interest rates and vice versa.
  - The proportion of foreign-currency-denominated deposits in broad money tend to rise with a decline of interest rates; when interest rates were high in the late 1990s, the shilling was strong while a weak currency seems to have been concurrent with a low interest rate environment recently.

- Low short-term interest rates tend to be followed by high inflation:
  - Inflation in Kenya, amid high interest rates, was mild during 1998-2002, except a few brief episode of inflation slightly above 10 percent in 2000 owing to a severe drought.
  - Following the loosening of monetary stance starting in mid-2002, inflation starting from 2003, amid very low interest rates, was on average considerably higher than the previous period.

- Short-term interest rates do not seem to bear a significant relationship with real output:
  - The highly negative real interest rates associated with the sharp monetary expansion since mid-2003 seemed to have contributed to robust credit growth in 2004, yet the very high short-term interest rate environment in 1998 was also accompanied robust credit growth to the private sector.
  - Low-interest rate environment coincided with strong growth in real non-agricultural output in 2004, while similar environment in 2003 coexisted with a negative growth in real investment.
  - Historical evidence (1983–2004) indicates high short-term interest rates have not necessarily been followed by stagnation, while low short-term interest rates have not necessarily stimulated the economy.

### A VAR model for Kenya: model setup
- Structural form:
  - ttt XLCYLGε+=)()(, where G(L) is an n×n matrix polynomial, C(L) is k×n matrix polynomial, tY is 1×n vector of endogenous Kenyan variables, tX is 1×k vector of exogenous foreign variables, tε is 1×n vector of structural disturbances with Λ=)var( tε and Λ diagonal.
- Reduced-form:
  - tttt XLBYLAYμ++=)()(, with )(LA and )(LB matrix polynomials, tμ reduced-form disturbances with Σ=)var( tμ.
- Relation between structural and reduced-form:
  - )()(LHFLG += ; )()(
1
LHFLA
−
−= and )()(
1
LCFLB
−
=.
  - Errors: tt Fεμ 1− = or tt Fμε =, implying '11−− Λ=ΣFF.
- Identification:
  - Normalization of diagonal elements of F to unity; need 2/)1(−×nn additional restrictions motivated by economic theory.
- Exogenous vector tX:
  - [] FedOilCommX t =' where Comm = commodity price index based on Kenya’s main exports, Oil = world fuel commodity price index, Fed = U.S. Federal Fund’s rate.
- Endogenous vector tY:
  - [] tttttt NEERSMCPIGDPY=' with real GDP, CPI, money stock (M), short-term interest rate (S), and NEER.
- Benchmark choices:
  - Money stock (M) = M3X.
  - Short-term interest rate (S) = REPO rate.
- Data and estimation specifics:
  - VARs estimated in levels using monthly data between 1997 and 2005.
  - All variables seasonally-adjusted and expressed in logarithms, except interest rates in percentage terms.
  - Standard information criteria select lag length = 5.
  - A sequential Chow test suggests no evidence of structural breaks at the 5 percent confidence level.
  - Monthly GDP obtained by interpolating annual GDP based on monthly production data of key sectors.

### Identification schemes
- Identification Scheme One: Recursive VAR (Cholesky)
  - Ordering: GDP, CPI, M, S, NEER (as in vector (6)).
  - Assumes CPI has no immediate effects on GDP; M has no immediate effect on CPI; S has no immediate effect on M; NEER has no immediate effect on monetary policy.
- Identification Scheme Two: Non-Recursive Structural VAR
  - Relaxed contemporaneous restrictions following Sims and Zha (1998) and Kim and Roubini (2000).
  - Interpreted system:
    - First two equations: sluggish response of real GDP and prices to nominal shocks.
    - Third equation: short-run money demand responding contemporaneously to output, prices, and short-term interest rates.
    - Fourth equation: monetary policy reaction function responding contemporaneously to money demand and exchange rate, not immediately to contemporaneous output and price shocks.
    - Fifth equation: nominal exchange rate responds immediately to all other variables.

### Estimation results (benchmark model, January 1997–June 2005)
- Impulse responses to a one-standard deviation monetary policy shock (an exogenous, unexpected, temporary rise in the REPO rate at t=0) with 95 percent confidence bands (bootstrapped with 500 replications):
  - Output:
    - The effect on output appears to be insignificant; impact is not statistically distinguishable from zero over the next 36 months (horizontal axis broadly within the 95 percent confidence band).
  - Prices:
    - Monetary shock has a significant and persistent impact on prices.
    - An unexpected and temporary rise in the short-term interest rate is followed by a decline in prices, with the effect peaking at 9 to 12 months after the shock.
  - NEER:
    - NEER responds strongly to a monetary shock.
    - An unexpected and temporary rise in the short-term interest rate tends to be followed by nominal appreciation, with the impact culminating 9-12 months after the shock.
- Forecast error variance decompositions (Figure 10):
  - Under both recursive and structural VARs:
    - Monetary shock accounts for one third of the fluctuations in prices.
    - Monetary shock accounts for a half of the fluctuations in the nominal exchange rate.
    - Around a tenth of the fluctuations in output can be attributed to the monetary shock.
- Non-agricultural output:
  - Substituting non-agricultural output for GDP yields similar results: monetary policy has little impact on non-agricultural output.
- Robustness:
  - Results are qualitatively robust to identification scheme (recursive vs structural), alternative definitions of monetary policy shock (rise in interbank rate instead of REPO), and using reserve money instead of M3X as the money variable.
  - Varying the sample start year (1998, 1999, 2000 vs benchmark 1997) yields broadly similar impulse responses.

### Economic interpretation
- Monetary policy primarily affects nominal variables:
  - Tightening (rise in short-term interest rates) tends to appreciate the nominal exchange rate, likely reflecting capital mobility induced by interest rate differentials.
  - Exchange rate appreciation makes imports cheaper, decreasing the overall price level and the rate of inflation.
- Weak transmission to real sector:
  - Monetary policy seems to have little impact on real output.
  - Plausible explanation: structural weaknesses in the financial sector hamper transmission (weak legal framework, poor governance, insufficient infrastructure), leading to high interest rate spreads, inadequate financial intermediation, and heightened risks.
- Policy implications:
  - Given the weak link between output and monetary stance amid a strong link between price stability and monetary stance, there seems little scope for balancing output stabilization and price stability.
  - Near-term overriding objective of monetary policy should be to maintain low inflation.
  - Structural reforms recommended to improve monetary transmission:
    - Improving governance of the Central Bank of Kenya (CBK).
    - Strengthening the regulatory framework.
    - Enhancing the legal framework.

### Caveats and data limitations
- Sample period is relatively short; findings may pertain to idiosyncratic developments during the sample period and may not generalize to future behavior.
- Data quality concerns, particularly output data:
  - Large size of the informal sector may cause national accounts statistics to miss important activities influenced by monetary policy.

### Robustness analysis (appendix highlights)
- Stability of VAR:
  - Recursive Chow tests (p-values computed by bootstrapping) suggest the benchmark VAR is stable over the sample period; p-values are significantly higher than 5 percent so the null of stability cannot be rejected.
- Stability of impulse responses over time:
  - Impulse responses using shorter sample periods (starting in 1998, 1999, and 2000) are broadly similar to the benchmark case.
- Alternative variables:
  - Using the interbank rate as the monetary policy instrument produces similar impulse responses.
  - Using reserve money (CBK’s operating target) instead of M3X (CBK’s intermediate target) yields similar conclusions.

*IMF staff estimates (January 1997–June 2005, figures and tables as presented in the source).*

### REFERENCES

### _wp06300 - REFERENCES

### Monetary policy and transmission mechanism
- Aron, J., and J. Muellbauer, 2002. “Interest rate effects on output: evidence from a GDP forecasting model for South Africa.” IMF Staff Papers 49 (November, IMF Annual Research Conference): 185-213.
- Berdin, Don, and Gerard O’Reilly, 2004, “An Analysis of the Transmission Mechanism of Monetary Policy in Ireland,” Applied Economics, Vol 35, pp. 49-58.
- Brischetto, Andrea, and Graham Voss, 1999, “A Structural Vector Autoregression Model of Monetary Policy in Australia, “ Reserve Bank of Australia, Research Discussion Paper, 1999-11.
- Peersman, Gert and Frank Smets, 2003, “The Monetary Transmission Mechanism in the Euro Area: Evidence from VAR Analysis,” Monetary Transmission Mechanism in the Euro Area, Cambridge University Press.
- Sims, Christopher, and Zha, 1998, “Does Monetary Policy Generate Recessions?” Federal Reserve Bank of Atlanta Working Paper 98-12.

### Structural VAR, shocks, and macroeconomic dynamics
- Christiano, L., M. Eichenbaum, and C. Evans, 2000, “Monetary Policy Shocks: What Have We Learned and to What End?” in Handbook of Macroeconomics (Amsterdam: North Holland).
- Kim, Soyoung, and Nouriel Roubini, 2000, “Exchange Rate Anomalies in the Industrial Countries: A Solution with a Structural VAR Approach,” Journal of Monetary Economics, pp. 561-568.
- Sims, Christopher, 1980, “Macroeconomics and Reality,” Econometrica, 48(1), 1-48

### Country-specific empirical studies
- Durevall, Dick, and Ndung'u, Njuguna, 1997, “A Dynamic Model of Inflation for Kenya, 1974-1996,” IMF Working Paper No. 99/97 (Washington: International Monetary Fund).
- Saxegaard, Magnus, 2006, “Excess Liquidity and the Effectiveness of Monetary Policy: Evidence from Sub-Saharan Africa,” IMF Working Paper, No. 06/115 (Washington: International Monetary Fund).

### Statistical methods and theory
- Hall, P., 1992, The Bootstrap and Edgeworth Expansion, Springer, New York.

*References list as provided in the source PDF.*

---


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