*Will Malawi's Inflation Continue Declining? DOI: http://dx.doi.org/10.5772/intechopen.91764*


#### **Table 4.**

signified by the decline in average monthly growth of money supply from 2.3% over 2001–2011 to 1.6% over the period 2012–2019, and the fiscal consolidation efforts exacerbated by the withdrawal of donor funding. In line with the findings of Mangani [8] and Chavula [5], the results from this study indicate that the quantity theory of money to some extent does not seem to hold in Malawi, as the rising money supply seem to lead to a decline in consumer prices. Further analysis of the relationship between money supply growth and inflation rate shown that since 2000 the growth in money supply has persistently been lower than growth in overall inflation, averaging 3.8% and 15.5%, respectively over the period 2015Q1– 2019Q2 to some extent contributing to the forces dragging down inflation over the period. While fiscal deficits have had very minimal but significant impact on inflation over the period, with a positive impact in the first quarter before turning to having a negative impact in the second quarter. With the fiscal consolidation efforts being put in place, the time lag in affecting inflation could be suggesting that the funds have been directed towards some productive sectors which could have had a negative impact on inflation over the period. However, lending rates and exchange rates seem to be the main factors exerting positive inflationary pressures in the Malawian economy in the short run, while output initially exerts a negative impact before having a positive impact on inflation after a certain period conforming to

Durbin-Watson stat: 2.132180 2.132180

Breusch-Godfrey serial correlation LM Test: F-statistic 0.226575 (0.7982)

Heteroskedasticity test: ARCH: F-statistic 1.4387 (0.2345)

**Variable Coefficient Std. error P-value** <sup>Δ</sup>*inft*<sup>1</sup> 0.522715 0.090417 0.0000 Δ*m*2*<sup>t</sup>* 0.121076 0.050711 0.0211 Δ*m*2*<sup>t</sup>*<sup>1</sup> 0.378424 0.065234 0.0000 Δ*m*2*<sup>t</sup>*<sup>2</sup> 0.267229 0.056639 0.0000 Δ*m*2*<sup>t</sup>*<sup>3</sup> 0.220042 0.050737 0.0001 Δ*it*<sup>2</sup> 0.118637 0.065816 0.0780 Δ*fdt* 5.31E05 1.33E05 0.0002 <sup>Δ</sup>*fdt*<sup>1</sup> 6.01E<sup>05</sup> 2.06E<sup>05</sup> 0.0054 <sup>Δ</sup>*fdt*<sup>2</sup> 4.56E<sup>05</sup> 1.51E<sup>05</sup> 0.0041 Δ*et*<sup>2</sup> 0.024740 0.006614 0.0005 Δ*et*<sup>1</sup> 0.016306 0.008573 0.0634 Δ*et*<sup>2</sup> 0.015709 0.007222 0.0348 Δ*et*<sup>3</sup> 0.025733 0.006304 0.0002 Δ*yt* 0.000295 0.000371 0.4308 <sup>Δ</sup>*yt*<sup>1</sup> 0.000582 0.000179 0.0021 *ectt*<sup>1</sup> 0.775206 0.085318 0.0000

*Linear and Non-Linear Financial Econometrics - Theory and Practice*

**Table 4** presents results of the long-run coefficients computed from the dynamic model shown above. The findings reveal that money supply growth, lending rate and

economic theory.

**260**

R-squared: 0.744337

*Short-run ARDL error correction regression results.*

**Table 3.**

*Long run ARDL estimation results.*

fiscal deficit appear to have a positive and statistically significant impact on inflation in the long-run. Money supply growth and lending rate are found to have a positive and statistically significant impact at below 1% level of significance, whereas fiscal deficits are found to be significant at 10% level. To some extent signifying the negative effects of increased fiscal deficits due to the weakening of the country's fiscal consolidation efforts in the long run and also the impact of county's spending on its early 2019 elections. Output gap is found to have a negative and significant impact on inflation at below 1% level of significance, which conforms to the existing theoretical literature.

The chapter further examines whether there has been any change with regards to what has been driving inflation before and after the exchange rate regime change in 2012. The study again uses the same ARDL model framework based on Eq. (2) applied over the two separate periods, 2001–2011 and 2012–2019. The short-run results covering the period 2001–2011 (the period before the regime change), show that money growth, lending rate, fiscal deficit, output and import price had an instantaneous positive impact on inflation over the first few months, before rebounding and absorbing the shock soon after, especially through increases in output and money growth. On the other hand, fiscal deficits and import prices had an instantaneous negative impact on inflation before exerting inflationary pressures soon after the first quarter. While nominal exchange rate had a significant negative impact on inflation, to some extent reflecting the impact of price controls as they weakened its impact in the short-run over the period.

The long-run estimation results show that between 2001 and 2011 money supply growth exerted significant inflationary pressures in the Malawian economy, while import prices had had a negative and significant impact on inflation as monetary authorities operated a de facto pegged exchange rate regime over the period (see **Table A1** in the Appendix).<sup>4</sup> This result to some extent could be attributed to the capital management and price controls operated before 2012 by monetary authorities (see [1] for more details). However, the exchange rate is found to have a positive but insignificant impact on inflation, while output gap has a negative but insignificant impact on inflation in the long-run.

After floating the exchange rate and implementing the oil price automatic adjustment mechanism covering the period 2012–2019, the short-run estimation

<sup>4</sup> Though not reported, kindly not that the model estimation methodology followed all the necessary analytical and evaluation tests assessing its suitability for analysis.

results show that inflation was mainly affected by changes in the nominal exchange rate, with a 1% depreciation leading to a 0.01 percentage increase in inflation rate. However, increases in output are found to have outweighed inflationary pressures as output led to a significant decline in inflation over the period, with a 1% increase in output leading to a 0.004% decline in inflation rate with a 3-month time lag.

**5. Conclusions**

*Will Malawi's Inflation Continue Declining? DOI: http://dx.doi.org/10.5772/intechopen.91764*

In this paper we have tried to examine the main factors behind the country's inflation dynamics since 2001, putting emphasis on the factors behind its continuous decline since early 2013. We have also tried to assess if at all this decline will persist as per the performance of the underlying economic fundamentals both in the

The results of the study show that based on the full sample (2001–2019), money

Inflation dynamics in the period before the change in exchange rate regime are found to have been influenced mainly by money supply, interest rates, exchange rate movements and import prices in the short-run while in the long-run inflation was mainly influenced by changes in import prices. The results based on the subsample (2012–2019), capturing the period after the exchange rate regime change, the decline in inflation is found to have been mainly influenced by output growth in the short-run while exchange rate movements exerted inflationary pressures in the economy over the period. However, in the long-run, import prices continued to

The results from the forecasting process reveal that inflation rate might not continue declining as has been the case over the past few years if the status quo stays as it is currently. The forecasts show that inflation rate may increase up to 19.4% by the end of 2020. Monetary authorities should therefore continue to put in place measures that will control money supply growth, import prices and maintain exchange rate stability as these seem to be the main drivers of inflation in the short-

The results seem to suggest that, while price stability remains the principal objective of monetary authorities in the country [7], they should not only place more emphasis on the objective of stabilization and achieving low inflation, but also focus on supporting strong, sustained and shared growth, as output seems to play a significant role in bringing down inflation in the country. As they continue to put money supply, fiscal deficits and exchange rates in check, they should ensure that the strategies being implemented and the associated transmission mechanisms aim at increasing the country's output growth. In line with the findings of Simwaka et al. [15], these results may be suggesting that the movement and relationship between inflation and money growth could be further suggesting that while monetary and fiscal policy tightening remain central to lowering inflation, structural measures to boost productivity and growth in the economy remain necessary in ensuring a more

Noting very well that cutting of interest rates that the country has undertaken recently could not bear fruits if the economy does not produce enough goods and services to meet the existing demand, lack of supply would lead to a rise in inflation,

In line with the findings of Mangani [8] and Chavula [5], an increase in money

supply seems to lead to a decline in inflation and the increase in interest rates seem to lead to a decline in prices. These results to some extent indicate that the quantity theory of money does not seem to hold in Malawi. To some extent suggesting the need for the continued use of reserve money and money supply to

which force monetary authorities to raise interest rates again.

supply, fiscal deficits and output growth had a significant negative impact on inflation in the short-run, while exchange rate movements and interest rates exerted inflationary pressures in the economy over the period. However, results reveal that only output had a significant negative impact on inflation in the long-run over the same period, while money supply, interest rates and fiscal deficits exerted

short- and long-run amidst the existing opposing forces.

significant inflationary pressures in the economy.

have significant positive effects on inflation.

to medium-term in the country.

sustainable disinflation growth path.

control inflation.

**263**

The long-run results in **Table A2** show that inflation rate was found to have mainly been influenced by import prices over the period, reflecting the removal of price controls and floatation of the exchange rate. Analysis results show that between 2012 and 2019, a 1% increase in import prices led to a 0.2% increase in inflation. While over the short-run, results show that inflation was mainly affected by changes in the nominal exchange rate, with a 1% depreciation leading to a 0.01% increase in inflation rate. However, increases in output are found to have outweighed inflationary pressures as output led to a significant decline in inflation over the period.

Lastly, the analysis carried out earlier was used to provide the basis in providing the answer to the main question asked in the title of this paper, "Will Malawi's inflation rate continue to decline? To answer this question, we use the model estimated for the results in **Table 3** to produce forecasts based on the fundamentals that have been driving inflation in Malawi over the period 2001–2019. The model is firstly evaluated for its suitability for forecasting and its predictability power using the Theil Inequality Coefficient. The results of the evaluation (in **Figure A2(a)**) show that the model's predictive power is good since the value of the Theil Inequality Coefficient is close to zero. We also employed the CUSUM and CUSUM square tests to validate the stability of the model, and the results show that the plot of the CUSUM statistics stay within the 5% significance level, meaning that the estimates from the model are stable over the period under consideration, and could produce reliable forecasts. The model performance is also further evaluated by comparing the actual and the fitted values from the model. **Figure A2(b)** shows that the simulated values track the actual values well, thereby justifying the model's suitability for forecasting.

The results from the forecasting process (**Figure 2**) reveal that inflation rate might not continue declining as has been the case over the past few years if the status quo stays as it is currently. Inflation rate may increase up to 19.4% by the end of 2020 mainly driven by exchange rate variability, import prices and money supply as they are projected to rise significantly in the short- to medium term. Monetary authorities should therefore continue to put in place measures that will continue controlling money supply growth, import prices and maintain exchange rate stability as these seem to be the main drivers of inflation in the short- to medium-term.

**Figure 2.** *Inflation forecasts, 2001Q1–2020Q4.*
