THE IMPACT OF GOVERNMENT DOMESTIC BORROWING ON HEADLINE INFLATION IN MALAWI

Abstract

This study aims to determine whether there is any empirical support for limiting domestic borrowing to reduce upside inflationary pressures in Malawi, as suggested by a new orthodox neoclassical inflation theory such as the Fiscal Theory of Price Level (FTPL). The study investigates the short run and long-term effects of total domestic government borrowing on Malawi's headline inflation rate. The study adopts an Autoregressive Distributed Lag (ARDL) cointegration technique on time series for the period from 1980 to 2020 for Malawi to test the inflationary effect of government domestic borrowing while controlling for demand-driven inflation variables such as per capita Gross Domestic Product (GDP) growth, exchange rate growth (appreciation or depreciation), growth in money supply, and oil prices as a cost-push inflation driver. The analysis found that, while the FTPL holds in the short run at a significant level of 5.0%, inflation is insensitive to domestic government borrowing in the long run. On the other hand, the statistical significance of the exchange rate coefficient over the long term, even at 1%, indicates that Malawi's inflation is more imported and highly susceptible to fluctuations in the value of the local currency. These findings imply that policies aimed at import substitution, which would reduce the economy's high appetite for imports, and export base diversification, which would increase export levels, would help to reduce the rise in inflationary pressure.