THE IMPACT OF OIL PRICE SHOCK ON INFLATION, THE PASS -THROUGH EFFECT IN MALAWI

Abstract

Since 2000 the world has seen a resurgence of increasing oil prices which paralleled the 1978 and 1979 world oil price shock which had global repercussions. Several studies have been conducted so as to understand the magnitude of the impact of oil price fluctuation and the channels through which they affect the economy. This paper investigates the impact of international oil price fluctuation and the magnitude of the pass-through level to inflation, the pricing mechanism and the monetary policy response and its resultant impact on inflation in Malawi using data from 1985 to 2010.The study uses the triangle model of inflation, Phillips curve, to assess the relationship of the variables and estimate the Autoregressive Distributed Lag model (ARDL) so as to get the pass-through effect both in the short run and long run. The results show that money supply, oil price, interest rates and exchange rate variables have significant effects on inflation. However there is an incomplete international oil price changes pass-through to inflation which is even less compared to the exchange rate pass-through to inflation. Therefore inflation in Malawi is largely affected by shocks to the aggregate supply mainly through food prices which forms a large proportion of the consumer price index basket and the exchange rate fluctuation. Interest rates and money supply as instruments of monetary policy have very minimal impacts on inflation.