CENTRAL BANK OF KENYA
Remarks by
PROF. NJUGUNA NDUNG’U
GOVERNOR
.......... Hotel, Nairobi
March 16, 2009

Governor’s Remarks at A Meeting of the Actuarial Society of Kenya – March 16, 2009
REMARKS BY THE GOVERNOR A MEETING OF THE ACTUARIAL
SOCIETY OF KENYA – MARCH 16TH 2009
Chairman of the Actuarial Society of Kenya;
Members of the Actuarial Society of Kenya;
Distinguished Guests;
Ladies and Gentlemen:
It is both a pleasure and honour for me to speak here on a very topical and timely
issue in Kenya and I look forward to a lively and informative discussion. My talk
will focus on what monetary policy can do in providing support for economic
development in Kenya.
Let me start out by being clear on what I think we mean by “monetary policy”-
which I will take to mean the actions which are taken by central banks with a view
to influencing the quantity, cost and availability of money in the economy. These
measures consequently define the direction of the ultimate objectives of economic
policy.
The Central Bank of Kenya (CBK) was established in 1963 to replace the then
East African Currency Board (ECB). The ECB purely dealt with the issuance of
local currency for the East African countries (Kenya, Uganda and Tanganyika).
CBK’s current principal objective is formulation and implementation of monetary
policy directed to achieving and maintaining stability in the general level of prices.
This function is consistent with low stable inflation. The second principal objective
is to foster the liquidity, solvency and proper functioning of a stable market-based
financial system. This is achieved through its oversight function over commercial
banks and non bank financial institutions.

Governor’s Remarks at A Meeting of the Actuarial Society of Kenya – March 16, 2009
Like other central banks in the world, the CBK performs other functions including
promoting an efficient national payments and settlement system; issuance of
currency; provision of banking services to commercial banks and Government;
fiscal agent; management of the country’s foreign exchange reserves and
promoting the economic development agenda of Government, including its
objectives for growth and employment.
CBK’s monetary policy strategy is aimed at aligning the growth of broad money
(M3) to the target growth of real GDP (or total output of goods and services) and
the inflation rate. The ultimate target is inflation and broad money is the
intermediate target. The CBK impacts on these targets via an operating target
called reserve money. The reserve money comprises of CBK’s liabilities that
include currency in circulation and deposits of commercial banks held with it
(partly to facilitate interbank settlements and partly for overall liquidity
management).
In achieving its objectives, the CBK uses several monetary policy instruments
which include repurchase agreements (repos), reverse repos, term auction
deposits, and overnight lending to commercial banks, the Central Bank Rate
(CBR) and cash ratio. The repurchase agreements with commercial banks are
designed to fine tune interbank money market liquidity to ensure that the
operating target is achieved, while the CBR is purely a signalling rate which
indicates the direction to which interest rates ought to move. The cash ratio is a
direct credit control instrument, which works by enhancing or reducing the ability
to create credit out of a given deposit base.
Monetary policy decisions are transmitted into changes in real GDP and inflation
through four channels: interest rate channel, credit availability channel (banklending channel and balance sheet channel), exchange rate channel and other
asset prices channel. There are strong indications that recent inflationary
pressures are not associated with money supply growth but largely reflect supply

Governor’s Remarks at A Meeting of the Actuarial Society of Kenya – March 16, 2009
side shocks emanating from drought and rigidities in the food distribution
networks. The trend of overall inflation mirrors trend of the food inflation
component in the consumer price index (CPI) basket. This however, does not
mean the risk for money based inflation is cleared. As a nation we have lived
through such phases before.
Direct interest rate
channel
Aggregate
demandAggregate
supply
interaction
Credit availability
channel:bankMonetary Policy lending/balancesheet
Instrument: Money
supply/short-term
interest rate Inflation
Other asset prices
channel: bonds,
equities and rent Real GDP
growth
Import
Exchange rate prices
channel
Monetary policy in any country matters and poorly designed monetary policy
strategies can result in costly economic crises. The Asian crisis of 1997 and the
collapse of the Argentina Currency Board arrangement of 2001 are stark
reminders that poorly designed monetary policy can cause economic problems.
Monetary policy can best contribute to economic growth over the medium-term
through its price stability function. Low and stable inflation is consistent with a
broadly stable macroeconomic environment, with an effective communication
strategy. Price stability improves the ability of the price system to spread
information about how resources are to be allocated to areas where they benefit
the citizens (through increased output and employment). In a market economy
like Kenya, it is the task of the price system to communicate information, for

Governor’s Remarks at A Meeting of the Actuarial Society of Kenya – March 16, 2009
instance about household preferences and, therefore provide signals to maximize
efficiency in the employment of the factors of production. Thus, inflation can
affect the wellbeing of the poor by influencing long-run growth and by influencing
the distribution of income.
• High inflation creates uncertainty, generates expectations of future
macroeconomic instability and distortionary policies, disrupts financial
markets, and creates high effective tax rates on capital.
• It discourages investment of all types: physical capital accumulation, human
capital accumulation, innovation, research and development, and foreign
direct investment and technology transfer. As a result, it can retard growth.
• High inflation may lower work effort and lead to rent seeking. This can also
erode a country's average standard of living.
• Inflation and macroeconomic volatility may harm some sectors of the
economy disproportionately. For example, inflation may be particularly
harmful to simple manufacturing or export-oriented industries. Depending
on the relative position of the workers in these industries, this can either
increase or decrease inequality.
• Finally, price stability is particularly beneficial for the political cohesion of
society, because inflation brings about an undemocratic redistribution of
economic resources.
It is because of the above that the “Economic Recovery Strategy for Wealth and
Employment Creation” (ERS) for the period 2003-2007 and the current Medium
Term Plan (2008-12) under Vision 2030 are partly anchored on macroeconomic
stability. The Medium Term Plan 2008-12 is the first phase of Vision 2030. The
Kenya Vision 2030 envisages that financial services will play a critical role by
providing better intermediation between savings and investments. This will assist
the mobilisation of investment funds that are required to implement the projects of
Vision 2030. The CBK is working to improve intermediation efficiency in the
banking system in support of Vision 2030 goals.

Governor’s Remarks at A Meeting of the Actuarial Society of Kenya – March 16, 2009
In recognition of the pivotal role of macroeconomic stability, the Central Bank took
steps at the end of last year to facilitate availability of liquidity and reduction in
interest rates by lowering the cash ratio from 6% to 5% and lowering the CBR from 9
% to 8.5 %. The policy measures were intended to ease liquidity tightness in the
money market (indicated by a protracted rise in the short term interest rates and
declining volumes of interbank trading). The measures provided the signal and the
basis for increased interbank trading at lower interest rates.
Besides the task of safeguarding price stability, CBK is also responsible for the
country’s national payment system. The proper functioning of a modern
economy requires that payments be carried out in a safe and efficient way. In
order for payment systems to function, it is important that financial stability is
maintained, through proper risk management practices in the banking sector.
There are close connections between the responsibility of CBK for price stability
and its responsibility for financial system stability. In order for the Central Bank’s
policy instruments to have the desired effect on interest rate formation, it is
important that the national payment systems function efficiently and securely,
since monetary policy instruments operate via the payment systems. Price stability
can further be threatened by financial imbalances and by financial instability. At
the same time a monetary policy focused on price stability per se reduces the risk
for financial instability. Thus, price stability and financial stability are both
required to create conducive conditions for economic growth, and CBK plays an
important role in achieving both goals.
Other no less important features of macroeconomic stability include low and
stable interest rates and stable exchanges rates. Low, positive and stable interest
rates promote savings mobilization and investment which is positively correlated
with economic growth. A stable exchange rate is a critical component in the
decision making process of economic agents. Unstable exchange rates introduce
uncertainty that affect decision. Kenya has a managed float exchange rate
regime, with interventions purely for smoothening out unwarranted exchange rate
fluctuations.

Governor’s Remarks at A Meeting of the Actuarial Society of Kenya – March 16, 2009
In conclusion, an appropriate monetary policy is a pre-condition for economic
development in Kenya and without it our aspiration for economic development as
stated in Vision 2030 will be severely impaired. Under the ERS 2003-2007,
economic growth recovered from near stagnation in 2002 to 7 percent in 2007.
The recovery process reversed in 2008 owing to effects of the post election
violence, high global commodity prices, drought, and the global financial crisis.
Even under these harsh conditions, the CBK is still keen to provide an enabling
macroeconomic environment characterized by price stability and low market
determined interest rates and market determined stable exchange rates.
Thank you very much for your attention.