The Financial Trilemma and Macroeconomic Instability: Empirical Evidence from Kenya

Lucas K. Njoroge
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Lucas K. Njoroge: Senior Economist, Comesa Monetary Institute (CMI), P.o Box 12301-00100, Nairobi, KENYA

American Journal of Trade and Policy, 2015, vol. 2, issue 2, 59-70

Abstract: The study aims to test whether the financial trilemma holds for a small open economy and examine the implication of the implicit financial trilemma configuration on macroeconomic instability using Kenyan data. First, the study constructs the trilemma and macroeconomic instability indices and tests the financial trilemma. Second, the study empirically examines the effect of financial trilemma on macroeconomic instability. The results show that the financial trilemma does not hold for Kenya. However, the trilemma indices are statistically significant by using the overall foreign participation to total equity turnover as a measure of financial openness. The results imply that the increasing economic vulnerability is potentially driving the Kenyan economy towards a financial trilemma characterized by a delicate balance of improving monetary independence and exchange rate stability. Financial transparency is associated with increased macroeconomic instability. International reserve accumulation acts as a buffer and does not cause macroeconomic instability, implying that the Central Bank of Kenya conducted effective sterilization during the study period. This is the first study to test for the financial trilemma using Kenyan data. This study differs from other similar studies in several important ways. First, the study constructs alternative financial trilemma indices that reflect the various reforms taking place in Kenya. Second, the study uses a unique data set based on the newly released quarterly GDP data, unlike most other studies that depend on annual data.

Keywords: Financial Trilemma; Openness; Macroeconomic Instability; Kenya (search for similar items in EconPapers)
JEL-codes: F31 (search for similar items in EconPapers)
Date: 2015
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