EFFECT OF SELECTED MACROECONOMIC VARIABLES ON UNEMPLOYMENT IN KENYA.

Abstract

Unemployment remains a major challenge and key concern for policymakers. Despite undertaking interventions such as public work programs, targeted employment creation, among others, unemployment remains unresolved and even worsens, recording a sharp increase between 2017 and 2022 despite favorable macroeconomic conditions. This underscores the need for further empirical analysis to determine how the selected macroeconomic variables (economic growth, lending rate, development expenditure, and VAT) affect unemployment in Kenya. This study applied a time series design, examining secondary data from 1991 to 2024. The Markov switching model with all parameters switching was superior among the existing models. In addition, the identification of a single break led to the fitting of a two-regime Markov switching model where Regime 1 represented a period of stagnating unemployment while Regime 2 represented a period of trend unemployment. The findings established that an increase in economic growth by one percent significantly reduced unemployment by 0.0256 % in regime 1 and 0.0658% in regime 2. On the other hand, an increase in the commercial lending rate by one percent reduced unemployment by 0.0008% in regime 1 and 0.0204% in regime 2. However, the effect was only significant in regime 2. Further, a one percent increase in development expenditure was found to significantly increase unemployment by 0.000259% in regime 1 and 0.0162824% in regime 2. Similarly, an increase in VAT rates by one percent increased unemployment by 0.0016% in regime 1 and 0.0794% in regime 2, with the effect significant only in regime 2. In addition, unemployment in the previous period increases unemployment in the current period by 0.94% in regime 1 and 0.70% in regime 2. The findings imply that policymakers should prioritize sustainable economic growth as the main driver of employment. Further, they should consider targeted VAT reforms, such as exemptions or reductions of VAT rates, especially during trend unemployment to stimulate demand driven consumption. Additionally, to counter the traditional effect of high lending rate, they should enhance access to credit.