An Alternative Medium-Term Strategy for Kenya’s Central Bank
Category: CurrencyEconomic GrowthEconomic PolicyMonetary Policy
By: Leo Kipkogei Kemboi,
The Central Bank of Kenya Act, (Cap 491) created the Central Bank as one of its autonomous agencies. The Central Bank’s mandate is to develop Kenya’s monetary policy, foster price stability, print money, and carry out other tasks assigned by a parliamentary act. The Constitution stipulates that the Central Bank of Kenya shall not be directed or controlled by any person or authority in the exercise of its powers or the performance of its functions to guarantee its independence and to ensure that its decisions shall be supported by evidence and free of the partisan politics that occasionally plague Kenya. However, like other institutions operating under the Kenyan Constitution, they are subject to examination and checks and balances from many players, with Parliament serving as the supreme authority.
Given the present economic climate and the country’s downside risks, the goal of this article is to suggest a contrarian agenda for the Central Bank. The following is a synopsis of the main concerns, not a comprehensive list. Issues about inflation, how it is not being properly targeted, and concerns about openness in monetary policy decisions form a key part of its analysis.
- Re-think the inflation band target and bring it forth to within a meaningful band
Looking at the inflation statistics for Kenya on the KNBS website, it is clear that during its entire history, Kenya has had periods of high inflation. Higher inflation over lengthy periods has unforeseen repercussions for prices, earnings, accumulation of wealth and the overall cost of life. A review of the deflator shows the kind of buying that has been depreciated away over those long inflationary periods. There are several particular effects of inflation on families, businesses, FDI generally, and general public perceptions of the economy. Kenyans usually suffer from inflation because they find it difficult to keep up with daily living expenses. Milton Friedman, a Nobel Prize winner, declared inflation to be a tax.
A further show that the inflation target is 5% (+/-2.5). Conventionally, the Kenyan central bank target inflation of 2% (+/- 0.5). this band gives the Central Bank leeway to promote prices within that range and take policy action if it is outside that range. Since it doesn’t lessen the expectations of a high inflation spectrum, this is a larger aim and is not intended to be used as an indicative guideline. Inflation targeting is ineffective in the first place, for instance, if the yearly average inflation rate has consistently averaged 5% and is linked to contracts and pricing expectations moving forward.
It may even imply that the Central Bank is measuring economic slack incorrectly and may be underestimating it. Also, it could be devastating to overestimate economic slack. Economic Slack describes the quantum of resources that are issued which includes people who can’t find a job[i]. This would indicate that the central bank may not be able to accurately predict current and potential inflationary pressures in the Kenyan economy and may consistently lag when making important monetary policy decisions.
There is concern that Kenya’s core inflation is low but the largely it is explained by food and fuel that is largely outsides the central bank’s control. However, all these sectors of the economy are driven largely by market performance. Market performance could be explained by the development of the markets and regulation of the markets. The central bank’s research should be on the frontier in guiding regulators and other markets on how to proceed in this kind of market.
One criticism levelled at Kenya’s food policy is that it aims to ensure producers receive the highest possible return at the expense of consumers. This type of policy is complemented by the fact that consumers have been denied access to the advantages of free trade due to trade protection measures and other countervailing measures. Any time there is a shock in the supply of food, prices skyrocket. The second charge is that the oil market’s import and distribution mechanisms do not adequately motivate market participants to import and distribute it, and as a result, the price observed is not the price determined by market forces.
It is regrettable that Kenyan leadership, including those at the central bank, were unable to foresee the impact that weather shocks would have on agriculture and its productivity in the early 1980s. At the time, vast portions of the water towers were being used for commercial purposes, and dry rangelands were not being reclaimed. Now that long rains have failed for five years in a row, Kenya is experiencing its worst drought in 40 years. It is a failure to give indicative research that either guided Kenya towards structural transformation of the Kenyan economy where the economy is not dependent on rainfed agriculture, or research that provides for investments in the Agricultural sector to reduce the impacts of climate change in Kenya.
However, a brief scan of the internet and the institutional records of the two houses of parliament and the central bank reveals that neither this research nor the suggestions that followed it have been sent to the appropriate committees of parliament or the government for action. As part of promoting the better economic management, the Central has to intervene directly through monetary policy, or indirectly by providing research with specific recommendations that can be taken up by relevant policy actors which allows the Central Bank to be always ahead of the curve in dealing with inflation.
2. Transparency on Monetary Policy Action and Currency
There have been various allegations in recent years that the Central Bank has implemented monetary policy every time the value of the Kenyan shilling has changed as a result of market fundamentals like the growing current account deficit and balance of payment issues given low export performance as compared to imports in the last decade. The claim that the strength of the Kenya shilling is supported by the Monetary Policy Action is supported by data because an evaluation of Kenya’s Real Effective Exchange Rate and Nominal Effective Exchange Rate (NEER) confirms the claim and the Central Bank has contrary opinions on the matter.
There is a divergence between NEER and REER over the last decade. Another analysis of the shilling’s strength in the market confirms it is supported by the monetary policy action[i].
Chart 1: Kenya’s Real and Effective Exchange Rates
Using this one example, it’s important to ask the central bank to maintain a position in the market that allows for intervention in times of volatility but also requires economic activity or fundamentals to drive the strength in currency either upwards or downwards. This is good practice and shows better judgement on the side of the central bank leadership rather than using monetary policy action on a normal basis, and losing the opportunity to intervene in times of crisis, which is a risk factor.
Conclusion
Periods of high inflation have characterized Kenya’s economic history. Inflation, according to Nobel laureate Milton Friedman, is a tax. Inflation has an impact on families, companies, FDI in general, and public perceptions of the economy. Kenyans are typically affected by inflation since they struggle to meet their daily living expenditures. Traditionally, the Kenyan central bank targets inflation of 2% (+/- 0.5%); this band allows the bank to encourage prices within or outside of that range. Kenya is suffering from its worst drought in 40 years, with five years of long rains failing in a row. Large sections of the water towers were being exploited for commercial reasons at the time, and barren rangelands were not being recovered. It is disappointing that Kenyan officials were unable to predict the impact of weather shocks on agriculture. As part of encouraging improved economic management, the Central must intervene directly or indirectly by conducting research and making specific suggestions that relevant policy players can implement.
When it comes to currency, it is vital to ask the central bank to maintain a position that allows for intervention during periods of volatility but still requiring economic activity or fundamentals to drive currency strength. The currency exchange price relative to other currencies, like any other price, should be free of any artificial interference. This is good practice and reflects superior leadership judgment than using monetary policy on a regular basis and missing the potential to assist in a crisis. This might include, among other things, improving the detection of new types of money laundering schemes and enhancing financial intermediation.
References
[1] Bank, European Central. “What Is Economic Slack?” European Central Bank, November 18, 2021. https://www.ecb.europa.eu/ecb/educational/explainers/tell-me-more/html/what-is-economic-slack.en.html.
[2] Ndii, David. “DAVID NDII – Shopping Mall Economics: A Note on the Value of the Kenya Shilling | the Elephant,” December 15, 2018. https://www.theelephant.info/op-eds/2018/12/15/shopping-mall-economics-a-note-on-the-value-of-the-kenya-shilling/.
[3] International Monetary Fund, Real Effective Exchange Rate as Based on Consumer Price Index for Kenya [KENEREERIX], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/KENEREERIX, November 9, 2022.
[4] International Monetary Fund, Nominal Effective Exchange Rate as Based on Consumer Price Index for Kenya [KENENEERIX], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/KENENEERIX, November 9, 2022.
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An Alternative Medium-Term Strategy for Kenya’s Central Bank
| Post date: Wed, Jan 11, 2023 |
| Category: CurrencyEconomic GrowthEconomic PolicyMonetary Policy |
| By: Leo Kipkogei Kemboi, |
The Central Bank of Kenya Act, (Cap 491) created the Central Bank as one of its autonomous agencies. The Central Bank’s mandate is to develop Kenya’s monetary policy, foster price stability, print money, and carry out other tasks assigned by a parliamentary act. The Constitution stipulates that the Central Bank of Kenya shall not be directed or controlled by any person or authority in the exercise of its powers or the performance of its functions to guarantee its independence and to ensure that its decisions shall be supported by evidence and free of the partisan politics that occasionally plague Kenya. However, like other institutions operating under the Kenyan Constitution, they are subject to examination and checks and balances from many players, with Parliament serving as the supreme authority.
Given the present economic climate and the country’s downside risks, the goal of this article is to suggest a contrarian agenda for the Central Bank. The following is a synopsis of the main concerns, not a comprehensive list. Issues about inflation, how it is not being properly targeted, and concerns about openness in monetary policy decisions form a key part of its analysis.
- Re-think the inflation band target and bring it forth to within a meaningful band
Looking at the inflation statistics for Kenya on the KNBS website, it is clear that during its entire history, Kenya has had periods of high inflation. Higher inflation over lengthy periods has unforeseen repercussions for prices, earnings, accumulation of wealth and the overall cost of life. A review of the deflator shows the kind of buying that has been depreciated away over those long inflationary periods. There are several particular effects of inflation on families, businesses, FDI generally, and general public perceptions of the economy. Kenyans usually suffer from inflation because they find it difficult to keep up with daily living expenses. Milton Friedman, a Nobel Prize winner, declared inflation to be a tax.
A further show that the inflation target is 5% (+/-2.5). Conventionally, the Kenyan central bank target inflation of 2% (+/- 0.5). this band gives the Central Bank leeway to promote prices within that range and take policy action if it is outside that range. Since it doesn’t lessen the expectations of a high inflation spectrum, this is a larger aim and is not intended to be used as an indicative guideline. Inflation targeting is ineffective in the first place, for instance, if the yearly average inflation rate has consistently averaged 5% and is linked to contracts and pricing expectations moving forward.
It may even imply that the Central Bank is measuring economic slack incorrectly and may be underestimating it. Also, it could be devastating to overestimate economic slack. Economic Slack describes the quantum of resources that are issued which includes people who can’t find a job[i]. This would indicate that the central bank may not be able to accurately predict current and potential inflationary pressures in the Kenyan economy and may consistently lag when making important monetary policy decisions.
There is concern that Kenya’s core inflation is low but the largely it is explained by food and fuel that is largely outsides the central bank’s control. However, all these sectors of the economy are driven largely by market performance. Market performance could be explained by the development of the markets and regulation of the markets. The central bank’s research should be on the frontier in guiding regulators and other markets on how to proceed in this kind of market.
One criticism levelled at Kenya’s food policy is that it aims to ensure producers receive the highest possible return at the expense of consumers. This type of policy is complemented by the fact that consumers have been denied access to the advantages of free trade due to trade protection measures and other countervailing measures. Any time there is a shock in the supply of food, prices skyrocket. The second charge is that the oil market’s import and distribution mechanisms do not adequately motivate market participants to import and distribute it, and as a result, the price observed is not the price determined by market forces.
It is regrettable that Kenyan leadership, including those at the central bank, were unable to foresee the impact that weather shocks would have on agriculture and its productivity in the early 1980s. At the time, vast portions of the water towers were being used for commercial purposes, and dry rangelands were not being reclaimed. Now that long rains have failed for five years in a row, Kenya is experiencing its worst drought in 40 years. It is a failure to give indicative research that either guided Kenya towards structural transformation of the Kenyan economy where the economy is not dependent on rainfed agriculture, or research that provides for investments in the Agricultural sector to reduce the impacts of climate change in Kenya.
However, a brief scan of the internet and the institutional records of the two houses of parliament and the central bank reveals that neither this research nor the suggestions that followed it have been sent to the appropriate committees of parliament or the government for action. As part of promoting the better economic management, the Central has to intervene directly through monetary policy, or indirectly by providing research with specific recommendations that can be taken up by relevant policy actors which allows the Central Bank to be always ahead of the curve in dealing with inflation.
2. Transparency on Monetary Policy Action and Currency
There have been various allegations in recent years that the Central Bank has implemented monetary policy every time the value of the Kenyan shilling has changed as a result of market fundamentals like the growing current account deficit and balance of payment issues given low export performance as compared to imports in the last decade. The claim that the strength of the Kenya shilling is supported by the Monetary Policy Action is supported by data because an evaluation of Kenya’s Real Effective Exchange Rate and Nominal Effective Exchange Rate (NEER) confirms the claim and the Central Bank has contrary opinions on the matter.
There is a divergence between NEER and REER over the last decade. Another analysis of the shilling’s strength in the market confirms it is supported by the monetary policy action[i].
Chart 1: Kenya’s Real and Effective Exchange Rates
Using this one example, it’s important to ask the central bank to maintain a position in the market that allows for intervention in times of volatility but also requires economic activity or fundamentals to drive the strength in currency either upwards or downwards. This is good practice and shows better judgement on the side of the central bank leadership rather than using monetary policy action on a normal basis, and losing the opportunity to intervene in times of crisis, which is a risk factor.
Conclusion
Periods of high inflation have characterized Kenya’s economic history. Inflation, according to Nobel laureate Milton Friedman, is a tax. Inflation has an impact on families, companies, FDI in general, and public perceptions of the economy. Kenyans are typically affected by inflation since they struggle to meet their daily living expenditures. Traditionally, the Kenyan central bank targets inflation of 2% (+/- 0.5%); this band allows the bank to encourage prices within or outside of that range. Kenya is suffering from its worst drought in 40 years, with five years of long rains failing in a row. Large sections of the water towers were being exploited for commercial reasons at the time, and barren rangelands were not being recovered. It is disappointing that Kenyan officials were unable to predict the impact of weather shocks on agriculture. As part of encouraging improved economic management, the Central must intervene directly or indirectly by conducting research and making specific suggestions that relevant policy players can implement.
When it comes to currency, it is vital to ask the central bank to maintain a position that allows for intervention during periods of volatility but still requiring economic activity or fundamentals to drive currency strength. The currency exchange price relative to other currencies, like any other price, should be free of any artificial interference. This is good practice and reflects superior leadership judgment than using monetary policy on a regular basis and missing the potential to assist in a crisis. This might include, among other things, improving the detection of new types of money laundering schemes and enhancing financial intermediation.
References
[1] Bank, European Central. “What Is Economic Slack?” European Central Bank, November 18, 2021. https://www.ecb.europa.eu/ecb/educational/explainers/tell-me-more/html/what-is-economic-slack.en.html.
[2] Ndii, David. “DAVID NDII – Shopping Mall Economics: A Note on the Value of the Kenya Shilling | the Elephant,” December 15, 2018. https://www.theelephant.info/op-eds/2018/12/15/shopping-mall-economics-a-note-on-the-value-of-the-kenya-shilling/.
[3] International Monetary Fund, Real Effective Exchange Rate as Based on Consumer Price Index for Kenya [KENEREERIX], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/KENEREERIX, November 9, 2022.
[4] International Monetary Fund, Nominal Effective Exchange Rate as Based on Consumer Price Index for Kenya [KENENEERIX], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/KENENEERIX, November 9, 2022.
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Unintended Consequences of Excise Tax on Tobacco and Nicotine Delivery Products in Kenya
In principle, Excise taxes are levied on goods and services whose consequences are considered socially undesirable. Most developing countries, including Kenya, rely on excise taxes for revenue. Furthermore, it can be used to achieve public health goals by discouraging the consumption of harmful products such as alcohol and tobacco, thereby addressing negative externalities of that […]
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The 12th Parliament has had its share of successes and setbacks. The sheer volume and diversity of legislation passed by the 12th Parliament demonstrate the effort made by legislators and committees in enacting both consequential and inconsequential government policies. The problem with increased volume is that it adds legal obligations to the already existing legal […]
A Regulated Kenyan
A look at the total income taxes collected by the government of Kenya in the Financial Year 2020/21 shows that collectively, working Kenyans paid a total of Ksh 694.1 billion for personal income taxes. While this is easy to compute, many Kenyan citizens are aware of how much of their income goes into taxes on […]
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