EFFECT OF CHANGES IN MACROECONOMIC VARIABLES ON AGGREGATE PRIVATE INVESTMENT GROWTH IN KENYA

Abstract

The research assessed the impact of fluctuations in macroeconomic variables on the growth of aggregate private investment in Kenya. The study aimed to: ascertain the impact of interest rate variations on the expansion of aggregate private investment in Kenya; evaluate the degree to which inflation rate fluctuations affect aggregate private investment growth; and examine the influence of exchange rate shifts on the growth of aggregate private investment in Kenya. Secondary data from the World Bank from 1972 to 2023, which included changes in the exchange rate, inflation rate, interest rate, and total private investment, was used. The analysis was based on four different ideas: Keynes's theory of interest rates, the flexible accelerator theory, Tobin's Q theory, and the eclectic theory. The analysis of the data was done with R. The Augmented Dickey–Fuller (ADF) test was used to find out the time-series properties of the variables, both at the level and at first difference. The findings indicated that private investment, interest rate fluctuations, and exchange rate variations were non-stationary at the level but attained stationarity after initial differencing, signifying I(1) processes. Changes in the inflation rate were stationary at a level, which means they were I(0). The Johansen cointegration approach was used because the variables did not have the same order of integration. The results indicated the lack of any cointegrating vectors, suggesting the absence of a long-term equilibrium relationship among the variables. The trace and maximum eigenvalue statistics being below the crucial levels at the 5% significance level backed up this result. Based on these findings, the investigation continued with the Autoregressive Distributed Lag (ARDL) estimate method. To see if the model was good enough, we did several diagnostic tests, such as the Breusch Godfrey test for serial correlation, the Jarque-Bera test for normalcy, and the Breusch Pagan test for heteroskedasticity. All diagnostics showed that the model was well-defined because the p-values were higher than 0.05. The ARDL estimations indicated that fluctuations in interest rates had a statistically significant adverse impact on the development of private investment in Kenya (p < 0.05). However, this effect was discovered to manifest after roughly three years instead of instantaneously. Changes in the inflation rate had a statistically significant beneficial influence on the increase of private investment (p < 0.05), and this effect lasted for about eight years. On the other hand, changes in the exchange rate did not have a statistically significant effect on the increase of private investment (p > 0.05). The Central Bank of Kenya should take into account the medium-term effects when making policy decisions about changes to interest rates. It should also keep a credible and consistent medium-term inflation target as the main guide for private sector investment decisions, while also making sure that macroeconomic stability is maintained through continued fiscal discipline. This will make sure that the economy is stable and that private investment in Kenya grows overall.