The Central Bank’s principal object is formulation and implementation of monetary policy directed to achieving and maintaining stability in the general level of prices. The aim is to achieve stable prices – that is low inflation - and to sustain the value of the Kenya shilling. Following amendments to the law, Section 4 paragraph (4) provides that the Minister for Finance may by notice in writing to the Bank
set the price stability targets of the Government.
Inflation
As is the case the world over, a central bank exists in a country to safeguard the value of its currency in terms of what it can purchase. When prices of goods and services in an economy keep of rising, the value of these goods and services that the currency can purchase –exchange for- diminishes. This leads to loss in value of the currency. Monetary policy is the main tool used in the preservation of the value of the currency in an economy. It involves the control of liquidity circulating an economy to levels consistent with growth and price objectives set by the Government. The volume of liquidity in circulation influences the levels of interest rates, and thus the relative value of the local currency against other currencies. It is the responsibility of the Monetary Policy Committee to formulate the monetary policy of the Central Bank of Kenya.
Maintaining price stability is crucial for a proper functioning of a market-based economy. It encourages long-term investments and stability in the economy. Low and stable inflation refers to a price level that does not adversely affect the decisions of consumers and producers. Price stability is a precondition for achieving a wider economic goal of sustainable growth and employment. High rates of inflation lead to inefficiency in a market economy and, in the medium to longer term, to a lower rate of economic growth.
movements in the general price level are influenced by the amount of money in circulation, and productivity of the various economic sectors, the Central Bank of Kenya regulates the growth of the total money stock to a level that is consistent with a predetermined economic growth target as specified by the Government and outlined in its Monetary Policy Statement
There are three major tools the Bank uses to implement monetary policy:
- Open Market Operations: Through open market operations, the Bank buys or sells securities in the secondary market in order to achieve a desired level of Bank reserves. Alternatively, the Bank injects money into the economy through buying securities in exchange for money stock. As the law of supply and demand takes effect to determine the cost of credit (interest rates) in the money market, money stock adjusts itself to the desired level. This process influences availability of money in the economy.
- Discount window operations: The Bank, as lender of last resort, may provide secured short-term loans to commercial banks on overnight basis at punitive rates, thus restricting banks to seek funding in the market resorting to Central Bank funds only as a last solution. The discount rate is set by the Central Bank to reflect the monetary policy objectives.
- Reserve Requirements: The Central Bank is empowered by the law to retain a certain proportion of commercial banks' deposits to be held as non-interest bearing reserves at the Central Bank. An increase in reserve requirements restricts commercial banks ability to expand bank credit and the reverse is regarded as credit easing.
The
Monetary Policy Committee (MPC) of the Bank sets the rate of interest at which the Central Bank charge on loans to commercial banks. This rate referred to as the Central Bank Rate (CBR). The rate signals the monetary policy stance of the Bank.