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THE DETERMINANTS OF INCOME VELOCITY OF MONEY IN KENYA(1992:1 – 2002:12)
BY
KING’ORI ZACHARIA IRUNGU
Thesis Submitted to the Department of Economics, University of Zimbabwe, in Partial Fulfilment of the Requirements for the Master of Science Degree in Economics.
University of ZimbabweJune 2003
 
ABSTRACT
The paper identifies the behaviour and extent of influence on money velocity in Kenya by real andmonetary factors. Four velocity functions are determined, which include currency in circulation,narrow money, broad money and extended broad money. The study also determines the stability of theKenyan velocity functions. The study’s time coverage includes the period of major financial reformsin Kenya (1992:1 to 2002:12). The reforms included the liberalization of the exchange market and theinterest rates. The necessity of the study emanates from the complexity that is associated with theinstability of money velocity and the associated targeting of major monetary variables.The paper utilises both descriptive and econometric methods to determine the velocity stability andthe extent to which the income velocity is affected by the stylised facts. The long run relationshipsand the short run dynamics are established through cointegration and error correction modelling. TheOrdinary Least Squares (OLS) method is utilised in the derivation of the parsimonious reductions of the over-parameterized functions. The stability of the velocity is determined via CUSUM tests,recursive residuals and recursive coefficient estimates.The results reveal that the short run money velocity is highly influenced by financial innovations andthe exchange market. The real interest rates also influence the income velocity although at a lesser significance, while the expected inflation rates are insignificant determinants. There is an inverserelationship between income velocity and real per capita income. The velocity function is also foundto be stable. The broad money velocity is found to be the ideal function for monetary policy.The exchange market and the financial sector therefore require close attention by the monetaryauthority. The results suggest that the government can obtain a great command over resources byissuing more money without causing inflation. The government can also generate inflation tax andgreatly utilise open market operations because of the low elasticity of inflation. The stability of thevelocity function simplifies the targeting of major monetary variables by the monetary authority.
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ACKNOWLEDGEMENT
I am indebted to some individuals and institutions that facilitated the completion of this study.Uppermost, I am highly indebted to my supervisor, Dr. P. G. Kadenge for his monetary economicslectures, time, advice and valuable comments which transformed the carrying of this study lesstedious. He has undoubtedly been the beacon of this study.Secondly, I am grateful to Prof. Rob Davies. He was the Chairman of the Department of Economics atthe University of Zimbabwe when I embarked on my Msc. (Economics) postgraduate studies. Hiswarm welcome gesture gave me the impetus and courage to embark on the studies which haveculminated in the completion of this study. My gratitude also extends to Mr. P. Mboya and Mr. M.Mallya whose company from the very beginning, contributed a lot in ensuring that my studies proceeded smoothly.Some institutions also deserve some mention. I thank the Ministry of Finance and Planning of theRepublic of Kenya, for offering me a study leave to undertake the Msc. Studies. I also greatlyappreciate the financial support extended to me by the African Economic Research Consortium(AERC), which contributed immensely to the completion of this study. I thank the Central Bank of Kenya (CBK) and the Kenya Central Bureau of Statistics (CBS), through their librarians, for allowingme to access the much required input data.Lastly, I wish to extend my appreciation to my parents, Mr and Mrs Michael King’ori for their upbringing and educational motivation. To them I say, “
 Ni ngatho nyingi muno
”.
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