Money supply and inflation in Malawi: An econometric investigation

Abstract

This paper examines the relative importance of monetary factors in driving inflation in Malawi. A stylized inflation model is specified which includes standard monetary variables, the exchange rate and supply-side factors. The results indicate that inflation in Malawi is a result of both monetary and supply-side factors. Monetary supply growth drives inflation with lags of about 3 to 6 months. On the other hand, exchange rate adjustments play a relatively more significant role in fuelling cost-push inflation. It is further observed that slumps in production generate inflationary pressures. At policy level, the Reserve Bank should ensure that broad money supply expands in line with nominal gross domestic product (GDP). However, it must be emphasized that monetary policy alone might not address other exogenous structural shocks considered as additional causes of inflation. What monetary policy can do is to slowdown the rate of inflation expectations by ensuring that prices in other categories of non-food items slow down. For example, it has been shown that exchange rate shocks have a strong effect on inflation. Given this finding, exchange rate stability is a key to anchoring inflation expectations, as the exchange rate pass-through in Malawi is relatively high. Finally, measures to control inflation must also emphasize enhancing production and supply, especially of food. Thus, inflationary control should aim at policies which are directed at both monetary and supply factors.