Cristopher Chimuka Munyonzwe

While financial innovation would likely promote high economic growth, fast financial developments may nevertheless hamper the effectiveness of monetary policy transmission. This study sought to determine the effect of financial innovation on the exchange rate channel of monetary policy in Kenya. The study employed an explanatory research design and used Multiple Regressions method as the analytical tool for determining the relationship between financial innovation and exchange rate transmission of monetary policy in Kenya. The study used quarterly secondary data drawn mainly from the Central Bank of Kenya publications for the period 2001 – 2010. The Consumer Price Index (CPI) was used as the dependent variable as this represents price stability which is one of the major goals of monetary policy in Kenya. From the regression results, it was found that the exchange rate becomes insignificant in explaining CPI volatility when it (exchange rate) is interacted with the financial innovation variables used in the study i.e. M2/M1 and BankCredit/GDP.

 Based on the results obtained, the study concluded that financial innovation weakens the exchange rate transmission channel of monetary policy in Kenya. Therefore, a policy of combining the channels of monetary policy transmission is recommended to the Central Bank of Kenya in order to achieve the desired outcomes.