Does Interest Rate Liberalisation Really Improve the Allocative Efficiency of Investment? Kenya's Experience

This study attempts to empirically investigate the impact of interest rate liberalisation on the efficiency of investment allocation in Kenya – using cointegration-based error-correction model. The study was motivated by the current debate on the efficacy of interest rate liberalisation on the one hand and the painful experience some countries have had with the liberalisation of interest rates on the other. Contrary to the results obtained from some previous studies, the results of this study find a distinct positive relationship between interest rate liberalisation and the efficiency of investment in Kenya. The study concludes that higher interest rates, which result from interest rate liberalisation, are likely to improve the average efficiency of investment in Kenya by transferring capital from projects with low returns to projects with high returns.