The study analyzed the interactions between, credit to GDP ratio, Money supply to GDP ratio, Debt to GDP ratio, Inflation rate, and Economic Growth in optimal stabilization outcome for financial variables while the interaction of these financial variables affects the normal stability of the economy as a whole. We employed PVAR modeling to show the interaction between financial instability in 12 East African countries from 1995 to 2019. The study shows how financial variables should respond together with financial instability by estimating impulse response functions (IRFs) and how the shock of one affect the growth of another variable by using variance decompositions factor (VDCs). The main hypothesis of this paper tests whether changes in one of them may lead to a considerable impact on financial instability and economic growth. It constructed models of CRGDP ratio, CRGDP ratio, Debt to GDP ratio, Money supply ratio, Inflation rate, and Economic growth and estimated these as a system with interaction variables using a VEC (variance decomposition) and impulse response function for interpreting the results. Of all these channels, the money supply is probably the most important way the host country’s economic growth is influenced by the CRGDP ratio. This happens to be the case because the CRGDP ratio influences inflation rate and financial instability more directly through this mechanism than through other channels. In an interaction between financial instability variables credit to GDP ratio followed by inflation rate account more percent in variation of GDP growth, Money supply ratio followed by GDP growth in the variation of credit to GDP ratio while credit to GDP ratio followed by GDP growth rate to money supply ratio. Moreover, the money supply ratio followed by the GDP growth rate accounts for more percentage in the variation of the inflation rate, while GDP growth is followed by a credit to GDP ratio in the variation of the Debt to GDP ratio. In general, the major reason for variation to each variable and the major cause for the response of these variables are their initial values. The study found that a shock on CRGDP ratio, Debt to GDP ratio, and Money supply hurts economic growth while the Inflation rate is positive; hence maintain money supply, debt ratio, and credit opt as advantageous for the economic growth of East and South African countries.

Keywords: Economic Growth, Financial instability, Impulse response function, Panel VAR