Optimal Monetary Policy with Output and Asset Price Volatility in an Open Economy: Evidence from Kenya

This paper attempts to establish optimal response of monetary policy to output, inflation and asset price volatility in a small open economy, taking into account optimisation behaviour of households and firms. The empirical analysis suggest that monetary policy responds to deviation of interest rate and output growth rate from their targets with greater weight compared to asset prices and inflation. The analysis also show that commitment to a monetary policy rule achieves output and inflation objectives as well as a higher level of welfare compared to discretionary monetary policy rule.