Mambo Chiluwe

The objective of the study is to determine the effect of monetary policy on private sector investment in Kenya, tracing the effects of monetary policy through the transmission mechanism to explain how investment responded to changes in monetary policy. Investment particularly in the sub Saharan African context was associated with Foreign Direct Investment (FDI), but the advent of the Asian financial crisis (1997/8) and the Global financial crisis (2008/9) have shown the fallacy of dependency on FDI. In the face of declining FDI and capital flight exhibited during financial crisii, policy makers have the task of making private sector investment the basis of economic growth. 

The study utilises quarterly macroeconomic data from 1996 to 2009 and the methodology draws upon unit roots and cointegration testing using a vector error correction model to explore the dynamic relationship of short run and long run effects of the variables due to an exogenous shock.

 The variables are stationary in first differences and using ordinary least squares a long run relationship is estimated that shows government domestic debt and Treasury bill rate are inversely related to private sector investment, while money supply and domestic savings have a positive relationship with private sector investment consistent with the IS-LM model.
Based on the empirical results the study suggests that tightening of monetary policy by -1 percent has the effect of reducing investment while the opposite loose monetary policy tends to increase investment. The finding of an error correction term (ECT) of -0.72 that is negatively signed indicates a move back to equilibrium suggesting that following an exogenous shock, 72 percent of the disequilibrium is corrected after one quarter. In the short run the variables adjust towards a long-term equilibrium in a dynamic adjustment process. 

The study concludes that domestic debt growth implies higher debt service payments raised from domestic capital markets and recommends limiting the growth of domestic debt which clearly has the capacity to crowd out private investment. Government of Kenya through the Central Bank of Kenya should facilitate a virtuous cycle of higher saving and investment rates, and higher trend growth by narrowing the spread between savings and lending rates to encourage savings mobilisation that anchors investment growth envisaged in the Vision 2030.