DYNAMIC EFFECTS OF EXTERNAL SHOCKS ON MALAWI’S INFLATION

Abstract

This study provides empirical evidence on the existence of a long run equilibrium relationship between inflation and its covariates in Malawi using the ARDL bounds testing approach to cointegration. The study uses monthly data for the period January, 2002 to December, 2010 and reveals that money supply, maize prices, industrial production, South Africa’s inflation, and the exchange rate play a dominant role in the long run inflationary process in Malawi. Fuel prices were found to be statistically insignificant in determining inflation in the long run, probably because of its link to the exchange rate which was the most important source of imported inflation in the short run. It is possible that in the short run, money supply may indirectly influence inflation via the exchange rate channel, an issue not investigated in the study. The study recommends that authorities in Malawi should consider adopting inflation targeting policy framework which has been successful in fighting inflation in South Africa, its main trading partner.