Feasibility of inflation targeting in an emerging market: evidence from Kenya

Purpose – The purpose of this paper is to assess the suitability of adopting inflation targeting in an emerging market, based on the pre‐conditions of inflation targeting identified in the literature. Design/methodology/approach – The study uses Granger causality and VAR approaches to assess the importance of the relationship between monetary policy variables and inflation. Findings – The findings indicate a dominant role of fiscal policy on both prices and output. The results therefore support the fiscal theory of price level, implying a need for incorporation of a fiscal variable in the design of monetary policy. The study also observes that the employment contract of the office of the governor is relatively short‐term and less than the Kenyan election cycle. The exchange rate is found to have no role on both prices and output. More importantly, the results show that the Kenyan economy does not meet all the conditions necessary for adopting inflation targeting. Originality/value – The study described in the paper is novel, as it is the first attempt the authors are aware of that empirically assesses the feasibility of inflation targeting in Kenya. The paper provides policy makers in emerging markets with useful information on the choice of appropriate policy frameworks for maintaining price stability. It also demonstrates the need for evaluation of any policy framework before adoption.