FISCAL AND MONETARY POLICY INTERACTIONS IN MALAWI

Abstract

This study analyses the nature of the interaction between fiscal and monetary policy in Malawi during the period 1980 to 2014. Accordingly, a Vector Autoregressive (VAR) analysis was employed to examine the issue of policy coordination and dominance by means of innovation accounting. The results of the study reveal that the two policies were weakly coordinated while the economy was characterized by a fiscally dominant regime during the study period. Consequently, fiscal policy must have been interfering with the monetary policy objective of price stability. As such, the study went further to explore the main channels through which fiscal policy becomes dominant and affects price levels in Malawi. Based on an examination of the causes of inflation variability, the study then concludes that fiscal policy mainly becomes dominant through its grip on money supply. Therefore, the nature of fiscal dominance in Malawi can best be explained by the Quantity Theory of Money (QTM) as opposed to the Fiscal Theory of Price Levels (FTPL).