The Impact of Financial Development on Inflation: Empirical Evidence from Kenya using the ARDL Approach

Abstract

This study delves into a comprehensive examination of the intricate relationship between financial development and inflation in Kenya, utilizing time series data spanning from 1973 to 2021. Within the empirical and theoretical realms, especially within country-specific contexts, the multifaceted dynamics of short-run and long-run impacts stemming from financial development on inflation have remained a significantly underexplored area. To address this research gap, we employ ARDL analysis, recognized for its sophistication and analytical rigor. The empirical findings from this study unveil a robust and enduring influence of financial development on inflation in Kenya over the long haul. Nonetheless, it's noteworthy that immediate evidence of financial development's impact on inflation appears relatively modest. Furthermore, the study unveils a complex interplay between interest rates and inflation, both in the short and long run, showcasing an negative relationship. These outcomes emphasize a substantial Granger and ARDL-driven causal link between inflation and financial development. Importantly, the policy implications arising from these empirical insights underscore the critical need for prudent financial sector oversight, focusing on fostering a climate conducive to stable and moderate inflation rates. This necessitates concerted efforts from both financial institutions and the government to fortify financial market infrastructures and bolster the uptake of financial services.