By Sheila Kaminchia
May 2015
This study looks for evidence of the fiscal theory of the price level in the data for Kenya. The fiscal theory of the price level envisages a situation where fiscal policy interferes with the effectiveness of monetary policy in controlling inflation primarily by occasioning an increase in private wealth. The study finds evidence that monetary policy in Kenya is active in determining inflation only one year after an initial policy response to inflation. Thereafter, fiscal policy becomes more significant in determining inflation. The study also finds that interest rates have a more significant effect on public debt than does reserve money. A monetary policy framework where the interest rate is a policy instrument would, therefore, be more appropriate in managing Kenya’s inflation over a medium-term horizon.