The Global Financial Crisis and Easing of Monetary and Fiscal Policies in Kenya: Has the Economy Achieved Internal and External Balance?

Topics: Monetary policy, Macroeconomics, Balance of payments Pages: 17 (5565 words) Published: July 11, 2010

CEC 702: Macroeconomics I
Assignment One

Submitted by: Peter Kitonyo
Registration No.: X80/81901/09
To: Dr. Rose Ngugi

29th January 2010

The global financial crisis continues to cause a considerable slowdown in most countries. Governments around the world are trying to contain the crisis, but many suggest the worst is not yet over. Stock markets went down by more than 40%. Investment banks have collapsed, rescue packages are drawn up involving more than a trillion US dollars, and interest rates have been cut around the world in what looks like a coordinated response. Leading indicators of global economic activity, such as shipping rates, are declining at alarming rates.

Rise in uncertainty in global financial markets has shaken the confidence in the financial system, exerting pressure on the tightening of financial conditions in most economies. Both of these factors are reflected in reduced consumption, exports and investments, leading to economic activity slow down and exerting pressure on fiscal indicators of budget revenues and budget deficit. On the other hand, the reduction of foreign currency inflows is accompanied by deterioration of the balance of payments indicators and the arising of depreciating pressures on exchange rate, underscoring the role of the current account stability on macroeconomic and financial balances at home and the need for taking precautions to guarantee it. In short, the financial crisis caused imbalances in both the internal and external balances of the economic systems of the world, Kenya included.

Consequently, most developed economies, USA, Euro-zone, United Kingdom, Japan as well as Kenya, eased their monetary and fiscal policies in order to hamper the economic downturn and improve the financial and capital markets situation. Kenya too, followed easing monetary and fiscal policies to deal with the impact of the crisis.

To understand the extent to which Kenya has achieved internal and external balances using the Monetary and Fiscal policies to deal with the effects of the financial crisis, this paper will examine the impact of the financial crisis on developing countries, theoretical framework for macroeconomic stabilisation, monetary and fiscal policy actions and outcomes in Kenya before drawing conclusions. The paper will however not address the causes of the global financial crisis.

Impact of the financial crisis on developing countries
The relationship between OECD GDP and Africa’s GDP has weakened as a result of the emergence of countries such as China, as well as structural changes in African economies. According to the IMF World Economic Outlook report in April 2008, a decline in world growth of one percentage point would lead to a 0.5 percentage point drop in Africa’s GDP, so the effects of global turmoil on Africa (via trade, FDI, aid) would be quite high. The correlation between African GDP and World GDP since 1980 is 0.5, but between 2000 and 2007, it was only 0.2. As there have been significant structural changes as well as the rise of China, African growth has temporarily decoupled from OECD GDP. Many developing and especially small and African countries are, therefore, in bad position to face yet another crisis. The terms of trade shock tend to be highest in small importing countries such as Fiji, Dominica, and Swaziland. However, African countries such as Kenya, Malawi, Tanzania are projected to have faced terms of trade shocks greater than 5% of GDP (World Bank paper for the October 2008 Commonwealth Finance Ministers meeting)

The current financial crisis was expected to affect developing countries in two possible ways; first there could be...

References: African Economic Outlook report on Kenya, (2010)
Baker, Dean (2008) “The housing bubble and the financial crisis,” Centre for economic and policy Research.
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Bookstabber, Richard (2007b) A Demon of our Own Design: Markets, Hedge Funds, and the Perils of Financial Innovation (Hoboken, New Jersey: John Wiley & Sons).
Central Bank of Kenya, (2009) “Monetary Policy Committee Meeting on 26th January 2010”, Press release
Central Bank of Kenya, (2009) “Monetary Policy Statement”
Central Bank of Kenya, (2008) “Monetary Policy Statement”
Central Bank of Kenya, (2009) “Statistical Bulletin June 2009”
Chong-Huey Wong, ( ), “Adjustment and the Internal-External Balance”
Dirk, Willem (2008) “The global financial crisis and developing countries” Overseas Development Institute.
Mundell, Robert A. (1962), “The Appropriate Use of Monetary and Fiscal Policy for Internal and External Stability”, Staff Paers-IMF, Vol. 9 No. 1 (Marc. 1962)
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“The Global Financial Crisis Challenges to Africa: Kenya experience and perspective” (A presentation by Central Bank of Kenya at the Ministers and Governors Forum in Tunisia 2008).
World Bank, (2009) “Still standing: Kenya’s Slow Recovery From Quadruple Shock”, (Edition No. 1 of Kenya Economic Update report)
Wong, Chong-Huey, ( ), “Adjustment and the Internal-External Balance”
World Bank paper for the October 2008 Commonwealth Finance Ministers meeting
Wray, Randal (2007) “Lessons from the Subprime Meltdown,” Levy Institute working Paper No
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