Impact of Monetary Policy on Inflation in Nigeria and Kenya: An Autoregressive Distributed Lag (ARDL) Approach

Abstract

This study examined the impact of monetary policy on inflation in Nigeria and Kenya motivated by persistent rise in inflation despite implementation of various monetary policy measures. Annual time series data covering 1990 to 2022 were obtained from the World Development Indicators (WDI). The study employed the Autoregressive Distributed Lag (ARDL) approach to examine both long-run and short-run relationships among the variables, while the Vector Autoregression (VAR) Granger causality test was used to determine the direction of causal relationships. Monetary policy variables such as money supply, lending interest rate, exchange rate and monetary sector credit to the private sector were used as explanatory variables. The results revealed the existence of a long-run relationship among the variables in both countries, the estimated long-run coefficients revealed mixed but largely significant impact on inflation except lending interest in Nigeria which was insignificant. Short-run dynamics revealed that
monetary policy variables exert both immediate and lagged effects on inflation in both countries with stronger effects arising from past inflation and lending interest rates, particularly in Nigeria, while the error correction mechanism indicates faster adjustment speed in Kenya relative to Nigeria. Granger causality results further showed a bidirectional relationship between inflation and lending rates in Nigeria, while Kenya exhibits predominantly unidirectional causal linkages among the variables. Overall, the findings suggest that monetary policy significantly influences inflation in both economies, though with varying degrees of effectiveness. The study concludes that enhancing monetary policy effectiveness requires strengthened monetary policies transmission channels, stabilizing exchange rate fluctuations, implementing inflation targeted lending rate, improved policy coordination, and complementary structural reforms to achieve sustained price stability.