Post on 02-Apr-2023
THE CATHOLIC UNIVERSITY OF MALAWI
FACULTY OF SOCIAL SCIENCE
DEPARTMENT OF ECONOMICS
THE EFFECTS OF MONETARY POLICY ON ECONOMIC GROWTH OF MALAWI
Economics Dissertation
PETER LAWRENCE DENGULE
(BsocEco 35/08/09)
SUBMITTED IN THE PARTIAL FULFILMENT OF THE REQUIRMENT FOR THE
AWARD OF A DEGREE IN BACHELOR OF SOCIAL SCIENCE IN ECONOMICS
DECEMBER, 2013
DECLARATION
I, the undersigned, hereby declare that this dissertation is
my original work and that, to the best of my knowledge, has
never been submitted for similar purposes to this or any other
university or institution of higher learning. Acknowledgements
have been duly made where other people’s work has been used. I
am solely responsible for all errors contained herein.
Student:
PETER LAWRENCE DENGULE
Date:
_________________________________________________________
ii
STATEMENT OF APPROVAL
The undersigned certify that this dissertation represents the
student’s own work and effort, and where he has used other
sources, acknowledgements have been made.
SUPERVISOR: MR NICKSON ERIC KAMANGA
(MA.Eco, Bsoc Sc.Eco)
Signature : ___________________________________________
Date : ___________________________________________
iii
DEDICATION
This work is dedicated to my parents: my father Lawrence
Maximiano Dengule who is a strong believer in education system
as a key to success. Mrs. Mercy. Dengule, I can never ask for
another mother. You are so kind. May God bless you.
It is also dedicated to my mother Maria Esnart Kufeyani who
never stops trying.
All in all, this work is dedicated to my son Brandon Dengule.
Things may have changed but life has to go on.
iv
ACKNOWLEDGEMENTS
I would like to thank God for the unconditional mercies upon
my life. He made a way where none believed there could be one.
I am forever in his debt.
Earnestly, I would like to thank my Parents and siblings. They
have been very supportive during the entire period that I was
v
in school. My family has always been the pillar to lean on
when school was very stressing. I love you all.
I wish to express my sincere gratitude to my supervisor, Mr.
Nickson Eric Kamanga, for his untiring efforts in guiding me
with valuable comments and advice in the course of writing
this paper.
I would also like to thank the entire economics department at
catholic university of Malawi for the efforts: Mr. F. M Banda,
Mr. A. G. Kachamba, and Miss L. kapesa
I would like to thank my classmates who contributed to the
success of this work: Maurice ‘ositivi’ Banda, Paul ‘Mswati-
mandingo’Malekano, Hopkins Kawaye, Limbani ‘Samalani’Msiska,
Zikhale Ngóma, sylvestre ‘Sensei’Tsokonombwe, Shadreck Sulani,
and Martin ‘madala-iva’Chinjala and all my friends, too
numerous to mention.
I would also like to thank the following people: Lisa Magwede,
Doreen Kaluma and Alfred ‘incucucu’Chilinda, Deo Muriya,
Hastings ‘Tsietso’ Saka, Dorica Katangala, Rachel Mkandawire,
Grace Ndacheledwa, Chisomo Sibale and Samuyele
‘nachimwadra’Makuti, Vinjeru Thindwa, Vivian ‘Mdyomba’Limbe,
Humphrey Longwe, Geoffrey Kumwenda, Success Sikwese, Adriano
Ndadzera, Mr. M. S Khomba and Mr. Chando of reserve Bank of
Malawi, Aubrey Ghambi, Mtendere Kachama and all the Manchester
United Funs at catholic university, you where like a family to
me.
vi
ABSTRACT
This paper was set out to investigate the effects of monetary policy on economic
growth of Malawi. It used an Autoregressive model and time series data collected
from the period 1980 to 2012 from the Reserve Bank of Malawi. Using E-views
Econometrics Package, the results suggested that there has been a significant
impact of monetary policy changes on the economic growth of the country.
Specifically, interest rates, money supply and liquidity reserve ratio displayed a
significant impact on economic growth of the country. Overall, therefore, the results
of the study indicate that there is a strong relationship between monetary policy and
economic growth of Malawi and there is need for policy makers to pay a particular
attention to money supply, interest rate and liquidity reserve ratio when deciding a
policy to implement that would lead to economic growth. This paper, in turn
highlights to policy makers areas to consider when designing monetary policies
being recommended or implemented appropriately, in order to ensure effectiveness
in fulfilling the intended objectives of growing the economy.
vii
TABLE OF CONTENTS
DECLARATION………………………………………………………………….…...i
CERTIFICATE OF APPROVAL………………………………………………..…....ii
DEDICATION……………………………………………………………………..…iv
ACKNOWLEDGEMENTS……………………………………………………….…..v
ABSTRACT...............................................vi
TABLE OF CONTENTS.....................................vii
LIST OF TABLES…………………………………………………………………….ix
LIST OF
ACRONYMS......................................................
.............................................x
CHAPTER ONE: INTRODUCTION…………………………………………….…...1
viii
1.1
Background...................................................
...................................................1
1.2 Problem
Statement....................................................
.......................................3
1.3 Objectives of the
study........................................................
.............................4
1.4 Specific
Objectives....................................................
.......................................5
1.5 Research
Questions.....................................................
.....................................5
1.6 Hypothesis of the
study........................................................
............................5
1.7 Scope of the
study........................................................
....................................5
1.8 Significance of the
study.........................................................
..........................5
1.9 Organisation of the
study.........................................................
ix
........................4
CHAPTER TWO: OVERVIEW OF MONETARY POLICY IN
MALAWI………………………………………………………………………………7
2.0
Introduction.................................................
....................................................7
2.1 Historical Background of monetary
policy.......................................................
.8
2.2 Recent Developments of Monetary Policy in
Malawi........................................
..............................................................
.........9
2.3 Monetary Policy Design in
Malawi........................................................
...........10
2.3.1 Liquidity Reserve
Requirement...................................................
..........................11
2.3.2 Base Rates (Policy
Rate).........................................................
..............................12
2.3.3 Open Market Operation
Operations....................................................
..................12
x
CHAPTER THREE: LITERATURE REVIEW………………………………………13
3.1
Introduction.................................................
....................................................13
3.2 Theoretical
Literature...................................................
...................................13
3.3 Empirical
Literature....................................................
...................................15
CHAPTER FOUR: METHODOLOGY……………………………………………...18
4.1
Introduction.................................................
...................................................18
4.2 Source of
Data.........................................................
.......................................18
4.3 Model
Spexcification...............................................
......................................18
4.4 Expected Signs of Explanatory
Variables....................................................
..19
xi
4.5 Diagnostic tests for the
study.........................................................
................19
CHAPTER FIVE: PRESENTATION AND INTERPRETATION OF
RESULTS....23
5.1
Introduction.................................................
.................................................. 23
5.2 Descriptive
Statistics...................................................
...................................23
5.3 Interpretation of Diagnostics results
...................23
5.4 Testing for serial
Autocorrelation.....................................24
5.5 Testing for the Goodness of
fit...........................................................
................25
5.6 Unit Root Test………………………………………..26
5.7 Interpretation of Regression Results
5.3.1 Interpretation of Regression Parameters
CHAPTER SIX: CONCLUSION AND POLICY RECOMMENDATION……...…29
6.1
Introduction.................................................
..................................................29
xii
6.2
Conclusion...................................................
..................................................29
6.3 Policy
recommendation...............................................
..................................29
6.4 Limitations of the Study and areas of further
research .................................30
REFERENCE………………………………………………………………………...31
APPENDIX………………………………………………………………….…….....34
xiii
Table 3: Estimated Regression Results
Table 4: RBM’s Monetary Policies, Trends and their Outcomes
Table 5: Regression Results
Table 6: Unit Root Test
xv
LIST OF ACRONYMS
AIC: Alkaike Information Criteria
GDP: Gross Domestic Product
GoM: Government of Malawi
LRR: Liquidity Reserve Ratio
M2: Money Supply
MPC: Monetary Policy Committee
OMOs: Open Market Operations
RBM: Reserve Bank of Malawi
REPOs: Repurchased Agreement
TBs Treasury Bills
xvi
CHAPTER ONE
INTRODUCTION
1.1. Historical background
Monetary policy is a technique that is used by central banks to
bring about economic growth and development. Monetary policy
works through the money market to affect output and employment
(Dornbusch, et al, 2004). Monetary policy can be traced back in
the time of Adam Smith (1771). The role of monetary policy is to
influence macroeconomic objectives such as economic growth, price
stability and stability in balance of payments. Monetary
authorities are therefore given the responsibility of using
monetary policy to improve the economy of the given country.
In Malawi, monetary policy plays a very important role in the
management of the economy. As outlined in the Reserve Bank Malawi
(RBM) Act of 1989, the principal objectives of the central bank
is to influence money supply, credit availability, interest rates
and exchange rates in order to ultimately promote economic
growth, employment and price stability (GoM, 1989). Achieving
these objectives clearly requires an understanding of the
transitions through which monetary policy affects economic
activities. The objectives of monetary policy in Malawi are:
price and financial stability, sustainable balance of payment and
economic growth (Chuka, 2012). Table 1 in the Appendix A
Page1
summarises the trends and the outcomes of the monetary policies
in Malawi since 1964.
There is an indirect link between monetary policy and economic
growth of a given country. Theory argues that interest rate which
is a tool of monetary policy has an effect on investment which
affects the real gross domestic Product (GDP) of a given country.
The real GDP is a commonly used indicator of economic growth.
Interest rates also affect net exports which also tend to have an
effect on the GDP (Dornbusch et al, 2004).
Economic growth is the increase in the values of goods and
services produced by an economy without inflation (Mishkin,
2003). It is conventionally measured as the percentage rate of
increase in real GDP. More importantly, economic growth can also
be referred to as intensive growth or the ratio of GDP to
population also known as GDP per capita. In economics, growth or
economic growth is usually calculated in real terms that is to
say, inflation adjusted terms-to eliminate the distorting effect
of inflation on the price of goods and services produced. It is
therefore generally agreed by economists that economic growth
typically refers to growth in real GDP.
GDP is equal to the total expenditures for all final goods and
services produced within the country in a stipulated period of
time (Mankiw, 2003). According to World Bank (2012), the GDP in
Page2
Malawi was worth 4.26 billion USD in 2012. The GDP value of
Malawi represents 0.01 percent of the world economy. Malawi GDP
averaged 1.61 USD Billion from 1960 until 2012, reaching an all-
time high of 5.62 USD Billion in December of 2011 and a record
low of 0.16 USD Billion in December of 1960.
Table 1 in the Appendix A shows how monetary policy instruments
have been changing since the existence of the RBM (RBM, 2012). As
shown in the table, the real GDP growth corresponds to the change
in monetary policy. This is evidenced in the table whereby from
the years 1964 to 1986, the RBM was using the following monetary
policy tools: interest controls, preferential lending and price
controls on selected commodities. This period, was known as the
period of financial repression. The exchange rate policy that was
used during this period was the fixed exchange rate regime. The
result was that the real GDP growth was recorded at 5.0%.
The years between 1987 to 1993 were a period of financial
reforms. The monetary policy tools that were used were as
follows: deregulation of lending rates, deregulation of deposit
rates, and the abolition of preferential lending rates. The
exchange rate that was used was pegged to a basket of currencies.
During this period, the real GDP growth declined from 5.0% to
3.3%. Indirect monetary instruments were used. The period between
1994 and 2007, was the period of financial liberalisation. The
monetary policy tools that were used during this period were:
Page3
discount rate, open market operation (OMO), liquidity reserve
ratio (LRR) and new commercial banks entered the system. The
exchange rate policies that were used included: free float and
partial deregulation of exchange controls. Real GDP growth was
recorded to be 3.2 (RBM, 2012).
However, there was a change in the instruments used in the
indirect monetary policy instruments in 2008 to April 2012. This
period was referred to as liberalised financial sector. There was
a restriction on the commercial banks to enter the system (RBM,
2012). The study used defacto fixed exchange rate with
administrative controls over current account transactions. The
real GDP growth was recorded at 6.0% from 3.2%. In May 2012, the
RBM maintained the indirect monetary policy but changed the
exchange rate from the defacto fixed exchange rate with
administrative controls over current account transactions to free
float with liberalised current account transactions. The real GDP
growth declined from 6.0 % to 1.6% (RBM, 2012). In the same
period, the GDP in Malawi also declined as depicted by the graph
below.
Figure1. Trends of GDP in Malawi from 2004 to 2012
Page4
This study was therefore meant to investigate if the fall in the
GDP level and the real GDP growth is attributed to the changes in
the combination of monetary policy and the exchange rate regimes
used.
1.2 Problem statement
There is a lot of literature on the factors that affect economic
growth in Malawi. However, there is no enough information on the
relationship between monetary policy and economic growth. The
major problem that this research paper was set to address was to
find out if monetary policy contributed to the fall of economic
growth (real GDP) in 2012.
Declining economic growth has adverse impacts on economic well-
being. Theory postulates that a period of declining growth ushers
in period of rising unemployment due to shrinkage of output
production (Dornbusch et al, 2004). In Malawi, a declining GDP
Page5
growth rate is associated with several adverse effects such as:
increase in price levels as it is the case when prices rose from
6% in 2011 to 35% in May 2012; shortage of fuel due to shrinkage
of export commodities and overvaluation of currency and its
resultant shortage in the formal market (RBM, 2013).
Conversely, stability in economic growth uplifts the living
standards of the people and attracts foreign investors into a
country (Dornbusch et al, 2004). Achieving stead state economic
growth is thus one of the major objectives of any country.
Monetary policy is one of the approaches to achieving such a
growth rate. A clear understanding of the effectiveness of the
different monetary policy instrument on economic growth should be
an area of concerned effort.
Related literature to this paper was done by Ngalawa (2009) who
looked at dynamic effects of monetary policy on shocks in Malawi.
Mangani (2011) also looked at the effects of monetary policy but
he drew his emphasis on the prices in Malawi. Ngalawa (2009) was
set to investigate the process through which monetary policy
affects consumer prices and output in Malawi. Using innovation
accounting in structural vector autoregressive model, Ngalawa
(2009) established that contrary to the official position that
monetary policy in the country targets reserve money only. He
further noted that monetary authorities in Malawi also target
short term interest rate. Ngalawa also noted that effectively,
Page6
the country employs hybrid operating procedures and it is
demonstrated that the bank rate is more effective measure of
monetary policy compared to reserve money. Consequently, this
present study was aimed at finding out how the monetary policies
have contributed to economic growth in Malawi.
1.3 Objectives of the study
The main objective of this study was to investigate the effects
of monetary policy on the economic growth of Malawi.
1.4 Specific objectives
To achieve the main objective, the study had the following
specific objectives.
1. To examine if the interest rates affect economic growth
2. To investigate if reserve required ration affects economic
growth
3. To scrutinise if money supply affect economic growth
4. To examine if inflation rate has an impact on economic
growth
5. To investigate the impact of real exchange rate volatility
on economic growth
6. To examine if the lagged real GDP has an influence on
economic growth
1.5 Research questions
Based on the objectives, the study aimed to address the following
questions:
Page7
1. Do the interest rates affect economic growth?
2. Does required reserve ratio affects economic growth?
3. Does money supply affect economic growth?
4. Does inflation rate affect economic growth?
5. Does the real exchange rate volatility affect economic
growth?
6. Does lagged real GDP have an impact on the economic growth?
1.6 Hypotheses tested
With respect to the objectives, this study aimed to test the
following hypotheses
1. Interest rates does not affect economic growth
2. Reserve required ration does not affect economic growth
3. Money supply does not affect economic growth
4. Inflation rate does not affect economic growth
5. Real exchange rate does not affect economic growth
6. The lagged real GDP does not influence economic growth
1.7 Significance of the study
The essence of this study is to add new knowledge on the
relationship betwee monetary policy and economic growth. In
particular, the aim of this study was to empirically scrutinise
the monetary policy tools that directly affect economic growth in
Malawi. However, the issue of economic growth has gained more
literature. The only drawback is that the existing literature
draws much emphasis on developed countries with lesser focus on
developing countries like Malawi. Taking into consideration the
Page8
importance of economic growth in a country, it is justifiable
cause that studies be carried out to add empirical knowledge on
the determinant of economic growth. The empirical findings of
this study are expected to bring an understanding of what
measures to be put in place for an improvement in the economic
growth and sustainable development.
1.8 Scope of the study
In order to effectively test the null hypothesis and also tackle
the research question posed, the study used time series data
which was collected at Reserve Bank of Malawi under the
department of information and research and development. It has
to be noted that the data collected was on various indicators of
economic growth which included: inflation rate, unemployment,
exchange rate, per capital income, balance of payment and gross
domestic product (GDP). The period of analysis for the study
covered the years from 1980 to 2012.
1.9 Organisation of the study
The first chapter has introduced the objective of the study and
its motivation. The rest of the paper proceeds as follows,
chapter two gives the the overview of monetary policy in malawi.
Chapter three discusses the theoretical and empirical literature
of monetary policy and economic growth. A detailed description of
the methodology and the diagnostic test to be carried out that
are associated with the model employed for the present study are
Page9
given in chapter four. Chapter five gives a presentation of
results for the estimated model but also the results of the
diagnostic tests conducted for the empirical model. Finally
chapter six concludes the discussion of the dissertation by
giving a summary of outcomes for the study together with their
policy implications, limitations of the study and directions for
further research.
CHAPTER TWO
2.0 An Overview of Monetary Policy
Monetary policy has lived under much simulation over the time in
memorial. Despite the way it may perform, it normally boils down
to adjusting the supply of money in an economy to achieve a
desired level of output and to stabilise the economy. Monetary
policy got its root from the works of Irving Fisher who laid the
foundation of the Quantity Theory of Money through his Equation
of Exchange (Diamond, 2003). In his proposition money has no
effect on economic aggregates but price. However, the role of
money in an economy got further elucidation from Keynes and other
Page10
Cambridge economists who proposed that money has indirect effect
on other economic variables by influencing the interest rate
which affects investment and cash holding of economic agents
(Keynes, 1930).
Monetary policy is generally conducted by the Central Banks such
as the Reserve Bank of Malawi. Most economists agree that in the
long run output is fixed, so changes in money supply will cause
prices to change but, however, in the short run, changes in money
supply can affect the production of goods and services. This is
because prices and wages usually do not adjust immediately. As
such monetary authorities are saddled with responsibility of
using monetary policy to grow the economy.
Views differ in the weight placed on money, credit, interest
rates, and asset prices (Ngalawa, 2009). The differences have
been prevalent even in individual developed economies where the
topic has also been a subject of research for many years.
According to Kamin, et al (1998), the process is even ambiguous
for developing countries. For example, despite the distinction
given to monetary policy, the transmission process in a typical
developing country is not well understood. Monetary policy refers
to actions taken by the central bank to influence the amount of
money and credit in the economy. In doing so, the central bank
can determine the level of consumption or investment spending and
hence influence the rate at which domestic prices grow and the
Page11
level of growth in the economy. Monetary policy operates through
the financial system- mainly commercial banks which will transact
their business influenced by the signals from the Central Banks.
In controlling the amount of money (deposits, notes and coins in
circulation), or the amount of credit (amounts that banks and
other finances houses can lend), the Central Bank will influence
the level of activity within the economy (Lattie, 2000).
2.1 Historical Background of Monetary Policy in Malawi
The RBM became operational in 1965 and was established by an act
of Parliament which was passed in July 1964. During that time,
the principle objectives of the RBM were limited to issuing legal
tender in Malawi, maintaining external reserves so as to
safeguard the external value of the Malawi Kwacha and promoting
monetary stability and developing a sound financial system, In
addition to the traditional role of being a banker to the
government.
The conduct of monetary policy in Malawi since independent can be
outlined in three broadly distinct monetary policy regimes and
these are: period of financial repression (1964-1986), period of
financial reforms (1987-1994) and a period of financial
liberalisation (post-1994) (Ngalawa, 2009). During independence
in 1964, the formal banking system which the country adopted from
the colonial government was perceived to be primarily interested
in serving the needs of an expatriate community, to have little
Page12
interest in direct lending to local entrepreneurs, and to impose
unreasonably high charges on routine banking services. To get
rid of these distortions, direct controls on credit and interest
rates were imposed. The agricultural sector, in particular, was
accorded preferential lending rates and quota credit allocations
in line with government policy to promote agricultural
production. Besides these controls, government also adopted a
fixed exchange rate system and imposed price ceilings on selected
commodities. Up until 1980s, monetary policy in Malawi was
characterised by repressive procedures such as direct credit,
interest rate ceilings, and strict controls on foreign exchange
rate and capital flows (Gondwe, 2001).
In the late 1970s, a hostile external environment forced the
economy into a deep recession, which persisted through the 1980s.
Intensifications of civil war in neighbouring Mozambique, a
consequent flooding of refugees into the country and disruption
of a cost effective route to the sea ports of Beira and Nacala;
the 1979 oil crisis; and drought in 1980 were some of the factors
that triggered the recession. The failure of the economy to
adjust to these shocks revealed structural weaknesses in the
design of the country’s macroeconomic framework. Government was
forced, therefore, to implement a policy change from the mid
1980s to the 1990s, moving away from direct to indirect tools of
monetary control, among others. A phased financial liberalisation
Page13
program targeted at enhancing competition and efficiency in the
financial sector was adopted (Ngalawa, 2009).
The reforms commenced with partial deregulation of lending rates
in July 1987 and deposit rates in April 1988. The partial
deregulation allowed commercial banks to determine their own
lending and deposit rates but not to effect any adjustment
without prior consultation with the central bank. Credit ceilings
were abolished in 1988. In January 1990, the authorities
announced the abolition of preferential lending rates to the
agricultural sector. Complete deregulation of the interest rates
occurred in May 1990 (Ngalawa, 2009).
The reform program also overhauled the legal and regulatory
framework of the banking system, which involved revision of the
RBM Act of 1964 and Banking Act of 1965 in May 1989 and December
1989, respectively. While the central bank was previously
supervising commercial banks only, the revised Banking Act
extended its coverage to include non-bank financial institutions
(NBFIs), a function that was previously in the hands of the
Treasury. In addition, inspection of the financial institutions
was broadened to include adherence to prudential requirements
besides compliance to exchange control regulations (Ngalawa,
2009).
Page14
In line with the revised RBM Act, the central bank introduced two
new instruments of monetary policy, namely liquidity reserve
requirement (LRR) and discount window facility. The discount
window facility led to the introduction of the bank rate, which
has since become a very powerful indicator of monetary policy. A
change in the bank rate is usually followed by near instantaneous
corresponding changes in both lending and deposit rates. Average
yields on government securities also follow the same direction
(Kwalingana, 2007).
2.2 Recent Development of Monetary Policy in Malawi
The Malawi currency, the Kwacha, has suffered from a volatile
exchange rate. The Central Bank has attempted to intervene to
stabilise the currency but is constrained by very low foreign
exchange reserves (less than two months of import cover).
Interest rate remains very high. Base rates have been over 40% in
recent years, but were reduced to 25% in June 2004, and remain at
this rate. High real interest rates reflect the government’s
heavy domestic borrowing and also under developed and non
competitive banking sector. Such high rates have hampered private
investment a key driver of economic growth, in addition to
exacerbating the fiscal position (RBM, 2013).
2.3 Monetary Policy Design in Malawi
Page15
The Monetary Policy committee (MPC) is responsible for the
formulation of monetary policy in Malawi. The committee meets at
list once every month to review developments in the economy and
decide the appropriate course for monetary policy. This is in
line with current central banking practice in many countries
where monetary policy formulation is placed in the hands of a
committee in order to foster greater transparency, accommodate a
diversity of views, and avoid personal and political pressures on
the part of the Governor in policy decision-making. The MPC was
instituted in February 2000. It is chaired by the governor and
draws its membership from the Bank’s senior management, the
secretary to the Treasury (Minister of Finance), the secretary of
economic planning and Development and an independent member from
the academia. Policy decisions made during these are made public
through newspapers (RBM, 2013).
Operationally, the RBM seeks to influence the M2 (broad money
stock, consisting of currency outside banks plus demand and time
and savings deposits), money aggregate and domestic interest
rates to attain its macroeconomic objectives. As with many
developing countries, the design and conduct of monetary policy
in Malawi is strongly linked with International Monetary Fund’s
(IMF) monetary programming model (World Bank, 2013). Monetary
policy has largely been conducted through reserve money
programming in which the RBM sets monthly and quarterly
operational targets for reserve money, determined under the IMF’s
Page16
monetary programming. The first step in reserve programming is to
determine a target rate of growth in a broad monetary aggregate
that is consistent with the set macroeconomic objectives of
economic growth and price development. This requires that the
velocity of broad money demand can be predicted. The second step
is then to calculate the desired base money levels. The reserve
money programme can therefore be summarised as first setting an
intermediate target for broad money and second relating this to
an operational target for base money (RBM, 2013).
In terms of monetary policy operating instruments; before the era
of financial liberalisation, monetary policy in Malawi as
characterised by use of direct instruments such as direct credit,
interest rate ceilings and strict controls on foreign exchange
and capital flows. Open market operations were limited due to the
underdeveloped nature of the domestic securities market.
Similarly, the use of the liquidity reserve requirement ratio was
limited (Kwalingana, 2007).
Although these instruments were available, the effectiveness of
monetary policy was limited. This was partly due to the fact that
Malawi being a low income country, savings have been low
consequently financed deepening has remained low. As such, the
role of monetary policy in influencing macroeconomic performance
has been minimal (Kwalingana, 2007).
Page17
2.3.1 Liquidity Reserve Requirement
The tradition description of monetary policy generally emphasises
the reserve requirement constraint on banks.
Liquidity reserve requirement (LRR) refers to the proportion of
deposit liabilities that a financial institution holds (in the
form of readily acceptable means of payments) with the Central
Bank principally for the purpose of implementing monetary policy
objectives and a second for prudential purposes so as to safe
guard depositors interest (Sato, 2001).
In this case, banks are an important link in the transmission of
monetary policy because changes in bank reserves influence the
quantity of reservable deposits held by banks. Because banks
rarely hold significant excess reserves, the reserve requirement
constraint typically is considered to be binding at all times.
In Malawi, the LRR was first applied in June 1989 following the
revision of both the Banking Act and Reserve Bank of Malawi Act.
Section 38 of the banking Act (1989) and sections 30, 36 and 48
of the Reserve Bank of Malawi Act of 1989 authorise the Reserve
Bank to prescribe a minimum cash reserve balance which other
banks are required to maintain in the form of deposits with the
Reserve Bank. The LRR is justified on the need by the Bank to
provide uniform mechanism where the central bank may implement
monetary policy objectives to protect the external value of the
Page18
national currency and maintain a monetary equilibrium and also
assure adherence to prudential liquidity standards by individual
institutions (Kwalingana, 2007).
2.3.2 Base Rates (Policy Rate)
This is the rate of interest that the central bank charges
commercial banks for credit. It is mainly used as an indicator
for monetary policy stance that is whether the monetary
authorities are tightening or relaxing monetary policy
(Kwalingana, 2007). There is general agreement among economists
and policy makers that monetary policy works mainly through
interest rates. When the Central Bank policy is tightened through
a decrease in reserve provision, for instance, interest rates
rise. The rise in interest rates leads to a reduction in spending
by interest sensitive sectors of the economy, such as housing,
consumer purchases of durable goods and investment. Banks play a
part in this interest rate mechanism since a reduction in the
money supply which may consist of deposit liabilities of banks is
one of the principal factors pushing up interest rates (Amidu,
2006). A reduction in interest rates for example lowers the cost
of borrowing, which results in higher investment activity and the
purchases of consumer durables. The expectation that economic
activity will strengthen may also prompt banks to ease lending
policy which in turn enables businesses and households to boost
spending. In low interest-rate environment, shares become a more
attractive buy, raising households’ financial assets. This may
Page19
also contribute to higher consumer spending and makes companies
investment projects more attractive. Lower interest rates also
tend to cause currencies to depreciate.
2.3.3 Open Market Operations
Open market operations (OMO) are viewed as the primary tool for
monetary policy operations. In OMOs the Central Bank buys bonds
in exchange for money, thereby increasing the stock of money or
it sells bonds for money paid by the purchasers of the bonds,
thus reducing the money stock (Dornbusch, et al, 2004). Basically,
they involve the purchase and sale of securities to influence the
levels of liquidity in the economy. However, they are also
extensively used as a tool for financing a government budget
deficit.
The main instruments that are used for OMO are Treasury Bills
(TBs), auctions, RBM bills auctions and Repurchase Agreement
(REPOs) for both TBs and RBM bills. A Repurchase Agreement also
known as a REPO is the security together with an agreement for
seller to buy back the securities at a later date. The repurchase
price should be greater than the original sale price, the
difference effectively representing interest, sometimes called
the repo rate. Repo transactions are used to temporarily create
money, or reverse repos to temporarily destroy money which offset
temporary changes in the level of bank reserves conducted in the
secondary markets, and the instruments traded include TBs, RBM
Page20
bills, bankers acceptances and commercial paper. On the other
hand, TBs are also used for financing the fiscal deficit, RBM
bills are primarily a monetary policy instrument (RBM, 2013).
The TBs were introduced in 1991. They were zero coupon government
securities which originally had tenures of 30 days, 60 days and
91 days, but these were later adjusted to 91 days, 183 days, and
271 days tenors, respectively. On the other hand, the RBM bills
were introduced in August 2000 to complement TBs in monetary
operations and are offered in two tenors: 63 days and 91 days.
Auctions for both TBs and RBM bills are held weekly (Kwalingana,
2007).
CHAPTER THREE
LITERATURE REVIEW
Page21
3.0 Introduction
Achieving stable and sustainable economic growth has been a
challenge for Malawi’s economy. It has to be noted that achieving
stable and sustainable economic growth is crucial for developing
countries like Malawi whereby these countries are net importers
of goods and services with slow economic growth. This chapter
will discuss the theoretical literature review that contains the
major schools of thought on what the theory says on this topic.
Another section of this chapter will contain the empirical
literature view. This is what other authors have already written
on a similar topic.
3.1 Theoretical literature review
Theoretical literature review provides the relationship between
monetary policy and economic growth.
3.2 Major schools of thought in monetary policy
There are two schools of thoughts that talks about the
relationship between economic growth and monetary policy, these
schools of thoughts are; the Monetarist and Keynesian school of
thought. This section however will discuss the ideologies of
these two schools of thoughts on the relationship between
economic growth and monetary policy.
3.2.1 Classical School of Thought
Page22
The Classical Economists believe that Monetary Policy affects
prices, but not real Gross Domestic Product (GDP). The main
ideology under the Classical school of thought however is that
any policy tool for monetary policy will not influence economic
growth, but it will only cause inflation since the economy will
always be at full employment (Mankiw 2003). The impact of
monetary policy under the Classical School of thought can be
expressed by the equation of exchange or the quantity theory of
money given as follows;
MV= PY, where M = the quantity of money in circulation, V = the
velocity of money, P = the price level and Y = the real GDP.
Velocity is the number of times money is used to purchase the
goods and services in a given year, and the assumption is that it
is fixed and money supply is allowed to change. However the
effect of a change in money supply changes the price level (P)
while real GDP remains constant since the assumption is that the
economy is at full employment so any changes of money supply has
no effect on the real GDP. This is why under the Classical school
of thought it is argued that monetary policy only affect the
price levels in an economy (Mankiw, 2003).
3.2.2 Keynesian School of Thought
Keynesians posit that change in money stock facilitates
activities in the financial market affecting interest rate,
investment, output and employment. The main ideology of
Keynesians school of thought was that monetary policy influences
Page23
economic growth as well as the price levels. Their argument was
that the economy cannot be at full employment always, however
Keynesians school of thought believes that an increase in money
supply (expansionary monetary policy) would decrease interest
rates, increase aggregate demand, increase prices and output and
also decrease unemployment. This view however critics the view of
the monetarists which states that monetary policy will only
affect prices but not the growth in real GDP (Dornbusch, et al,
2004).
This study therefore will follow the Keynesians school of thought
that argues that monetary policy affects economic growth, with a
view of finding out the reliable tools for monetary policy that
influence economic growth in a country.
3.3 Empirical literature review
In Kenya, the study by Maturu (2007) used a structural Vector
Autoregressive model (SVAR) to argue that interest rate and
exchange rate channels are explicitly important channels of
monetary policy transmission in the country besides the
traditional money channel. On this basis, he pointed out that
there is potential for signalling monetary policy using the
repurchased agreement interest rate. This study agrees with the
study by Ngalawa in a way that they both concur to the use of
monetary policy to stabilise the economy.
Page24
A study by Ngalawa (2009) in Malawi was set out to investigate
the process through which monetary policy affects economic
activity in Malawi. The study employed monthly time series data
for the period 1988 to 2005. Using innovation accounting in a
structural vector autoregressive model, it is established that
monetary authorities in Malawi employ hybrid operating procedures
and pursue both price stability and high growth and employment
objectives. Two operating targets of monetary policy were
identified and these were: bank rate and reserve money and it is
demonstrated that the former is a more effective measure of
monetary policy than the latter. The study also illustrates that
bank lending, exchange rates and aggregate money supply contain
important additional information in the transmission process of
monetary policy shocks in Malawi. In addition, it is shown that
the floatation of the Malawi Kwacha in February 1994 had
considerable effects on the country’s monetary transmission
process. In the post-1994 period, the role of exchange rates
became more conspicuous than before weak, blurred process to a
somewhat strong, less ambiguous mechanism.
Another study in Kenya by Cheng (2006) also used a structural
Vector Autoregressive (SVAR) to examine the impact of monetary
policy shocks on output, prices and the nominal effective
exchange rate for the country during the period 1977 to 2005.
Cheng found out that an exogenous increase in the short term
interest rate is followed by a decline in prices and an
Page25
appreciation of the nominal exchange rate, but has insignificant
impact on output. He further showed that variations in short term
interest rates account for significant fluctuations in the
nominal exchange rate and prices, while accounting little for
output fluctuations.
However, a study by Mangani (2011) in Malawi looked at the
effects of monetary policy on prices in Malawi by tracing the
channels of its transmission mechanism, while recognising several
factors that characterise the economy: market imperfections,
fiscal dominance and vulnerability to external shocks. Using
vector autoregressive modelling, Granger-causality and block
exogeneity tests as well as innovation accounting analyses, the
study established the lack of unequivocal evidence in support of
a conventional channel of the monetary policy transmission
mechanism, and found that the exchange rate was the most
important variable in predicting prices. Therefore, the study
recommends that authorities should be more concerned with
imported cost-push inflation rather than demand-pull inflation.
In the short-term, pursuing a prudent exchange rate policy that
recognises the country’s precarious foreign reserve position
could be critical in deepening domestic price stability. Beyond
the short-term, price stability could be sustained through the
implementation of policies directed towards building a strong
foreign exchange reserve base, as well as developing a
Page26
CHAPTER FOUR
METHODOLOGY
4.0 Introduction
This chapter presents the model used to investigate the monetary
policies that affect economic growth in Malawi. The chapter
discussed the research strategy and the sources of the data that
was used that was used in this paper. In addition, this chapter
also discussed other important sections such as: the empirical
model that was estimated, the statistical package used, the
expected signs of the explanatory variables and finally the
diagnostic test employed in the study.
4.1 Research Strategy
In order to put up with the conventional methods and norms of
economic analysis, this study falls under the scope of
quantitative data analysis and makes use of economic approaches
to data analysis. More importantly, the nature of the topic and
variables being investigated renders it very necessary to employ
quantitative data analysis techniques.
4.2 Sources of Data
Page28
This study used time series data from the period of 1990 to 2013
collected from secondary sources namely: the Reserve Bank of
Malawi (RBM) and the Ministry of Finance.
4.3 Model Specification
In order to investigate the effect of monetary policy on economic
growth, an autoregressive model was employed. It is a model in
which the dependent variable depends on its lagged variable
(Gujarat, 2004). The rationale of using an Autoregressive model
in this study is based on the reason that, the current
performance of real GDP growth of a nation depends on the past
performance of the real GDP. Hence the employed model was given
as follows;
RealGDPt=α0+α1RealGDPt−1−α2∫¿t+α3RERt−α4LRt+α5Mst−α6INFLt+μt ¿ (1)
Where;
α0 represents the constant term, α0 represents the slope
coefficient or parameter for every fitted variable, GDPt denotes
the Gross Domestic Product at time t, realGDPt−1 is the lagged
variable of real GDP , ∫¿t¿ denotes the prevailing interest rate,
LRt represents the reserve required ratio, Mst is the money
supply at time t, INFLt denotes the level of inflation at the
given time and μt is the disturbance or the error term.
Page29
4.4 Description and expected signs of the explanatory variables.
The real GDP was used as the dependent variable of the study. It
was quantified by using the total national output realized by the
country’s fiscal year in its real terms.
The lagged variable of real GDP was included as the explanatory
variable of the study. The reason for including the lagged real
GDP variable was that the current economic performance of a
nation also depends on the past performance of its national
output (Gujarati, 2004). The economic assumption behind this
assertion was that the performance of national output in the
previous year will have a positive implication on the current
national GDP. Hence with this assumption the expected sign
coefficient of lagged GDP was positive.
Interest Rate has also been included as one of the explanatory
variables. Interest rate is defined as the cost of borrowing in
an economy (Dornbusch, et al, 2004). In this study interest rate
was measured as the bank rate set by the Reserve Bank of Malawi
as a tool of controlling money stock in an economy. The
assumption behind this variable was that when interest rate
increases they reduce aggregate private investment in an economy
resulting into a reduction in the total national product. This
calls for a conclusion that there is a negative relationship
Page30
between interest rates and real GDP growth, hence the expected
sign coefficient of interest rates was negative.
Exchange rate is defined as the value of one currency for the
purpose of conversion to another (Dornbusch, et al, 2004). In this
study exchange rate was also used as an explanatory variable. The
rationale of including exchange rate as an explanatory variable
was that the country’s export performance depends on the rate of
exchange. The export performance influences economic growth and
exchange rate adjustment is performed by the Central Bank, it is
justifiable to use it as an explanatory variable. The economic
assumption was based on the liquidity preference framework by
Keynes (1930), it states that an increase in exchange rate leads
to an increase in exports therefore leading to economic growth.
This calls for a conclusion that exchange rate should have a
positive expected sign.
The Reserve Required Ratio also known as the liquidity reserve
requirement was also included as another explanatory variable.
This is defined as the central bank’s regulation that sets the
minimum fraction of customer deposits and notes that each
commercial bank must hold as reserves. It is also a fraction of
deposits that commercial banks make to the central banks. This is
also used as one of the tools by the central bank in operation of
the monetary policy, when the liquidity reserve required
increases commercial banks end up having little money to lend out
in form of loans thereby reducing private investment and
Page31
aggregate consumption in an economy (Dornbusch, et al, 2004). Hence
liquidity required reserves was expected to have a negative
expected sign coefficient.
Money Supply is defined as the total stock of money circulating
in an economy (Mankiw, 2003). This has also been included as
another explanatory variable that influences economic growth. The
assumption here is that when the central back injects more money
in the economy individual will have more money to spend as such
increasing the aggregate demand. Therefore the expected sign
coefficient of money supply was positive.
Finally, Inflation was also included as an explanatory variable,
this is defined as the general increase in the level of prices
for goods and services in an economy (Mankiw, 2003). The economic
assumption of including inflation as an explanatory variable was
that, when inflation is high, goods and services become expensive
as such aggregated demand decreases. Hence the expected sign
coefficient of inflation was negative.
Page32
Table 1: Summary of Expected Signs for the monetary policies that
affect economic growth
Variable Parameter Expected signLagged GDP α1 +
Interest rate α2 -
Real exchange rate α3 +
Required Reserve
Ratio
α4 -
Money supply α5 +
Inflation rate α6 -
4.5 Econometric and Statistical Package to be used for the
Analysis
This study used E-views version 3.1 software packages to perform
diagnostic test and estimation of parameters.
4.6 Diagnostic Test to be used
This section discusses the diagnostic tests which were performed
to ensure that the empirical Autoregressive distributed-lag model
is free from some estimation problems.
4.6.1 Inclusion of irrelevant variables (model over fitting)
Model over fitting is a situation where irrelevant variables have
been included in the empirical model (Gujarati, 2004). To verify
the reliability of the point estimates, two tailed test of
significance will be picked for the study to determine the
Page33
acceptance or rejection of null hypothesis. For this purpose, 1
percent, 5 percent and 10 percent conventional level of
significance will be used. The null hypotheses to be tested here
are stated as follows:
: The value of slope coefficients for the monetary policy
that affects economic growth is zero.
: The value of slope coefficients for the monetary
policy that affects economic growth is not equal to
zero.
To test if inclusion of a particular variable is relevant to the
empirical model, the F-test statistic will be employed. We will
reject the null hypothesis when the probability value (P-value)
is less than the conventional level of significance.
4.6.2 Testing for the presence of Serial Autocorrelation
Presence of serial correlation is a situation when the error
terms in a regression model are correlated (Gujarati, 2004). To
test for the presence of serial autocorrelation in the regression
model a Durbin Watson tests (d-statistic) will be used. However
judgement will be based on the value of serial autocorrelation,
if the value of d-statistic is equal or closer to 2 then there
will be no presence of serial autocorrelation. If its value is
not closer to two or greater than 2 then the conclusion will be
that there is negative or positive serial autocorrelation.
Page34
4.6.3 Test for the Goodness of fit
This tests involves the testing if the model to be used fits the
data in the sample, it however involves the testing if the
employed model is of good functional form. If this diagnostics
will be reasonably good the conclusion will be that the chosen
model is a fair representation of reality. The judgement of this
diagnostic test will be based on the value of the calculated R-
squared, if the value of R-Square is low then the model to be
used is not of good fit (Gujarati, 2004).
4.6.4 Unit Root Test
This involves the testing of stochastic process in time series
data; however a stochastic process is said to be stationary in
time series data if its mean and variance is constant over time
and the also covariance between two periods (Gujarat, 2004). To
test for the presence of stationary Augmented Dickey-Fuller (ADF)
Unit Root test will be used. Its judgement however will be based
on a two tailed hypothesises.
Ho: The stochastic process is not stationary
H1: The stochastic process is stationary
When the calculated ADF value is greater than its critical value
or its p-value is less than the level of significance then we
will fail to accept the null hypothesis, and conclude that the
stochastic process is stationary.
Page35
4.6.5 Model selection criteria
Several tests will be conducted to find out if the chosen model
fits the data in the sample and to investigate how the fitted
model forecasts future values of the dependent given the value of
the explanatory variables. The criteria chosen for this study are
Alkaike Information Criterion (AIC) and Schwarz Information
Criterion (SIC). All these criteria which the study will employ
aim at reducing the residual sum of squares (RSS). All the
criteria impose a penalty for including an increasingly large
number of explanatory variables and as such there is a trade-off
between goodness of fit of the model and its complexity.
Page36
CHAPTER FIVE
PRESENTATION AND INTERPRETATION OF EMPIRICAL RESULTS
This chapter presents the empirical findings of the study. The
first section presents the descriptive statistics that were
undertaken, and the second section will present the diagnostic
tests and give the interpretation of the estimated regression
model.
5.1. Descriptive Statistic
Table 2 presents the descriptive statistics of the observed
variables in the study, these descriptive statistics have been
categorised into 3, mean, median, standard deviation, minimum and
maximum value.
Table 2: Descriptive Statistics
Page37
The table
indicates that the
mean Gross
National Product
(GDP) from 1980 to
2012 was MK410.5
thousand billion.
The standard
deviation of GDP
was 132.4
indicating that
there was a higher
deviation between
the mean GDP and the realised GDP in a given year. Furthermore,
the maximum GDP from 1980 to 2012 was MK784 thousand billion and
the minimum value was MK259 thousand billion Kwacha. On the other
hand average value of interest rates between the specified
periods was 27.13 percent, with a standard deviation of 13.3
indicating that there was a higher variability of interest rates
behaviour from 1980 to 2012. The highest value of interest rates
was 50.2 percent and the lowest value was 11 percent.
On average the inflation rate from 1980 to 2011 was 22.2 percent.
While the standard deviation was 17.2 percent indicating that
Page38
Variable Mean Std.
Deviati
on
Minimum Maximum
GDP 410.5 132.424
2
259.000 784.000
0INTEREST 27.125 13.338
25
11 50.2
INFLATION 22.204 17.198
31
7.4 83.5
EXCHANGE
RATE
81.901 79.0062
3
2.65000
0
334.570
0MONEY
SUPPLY
71112.
9
106028.
7
732.100 386435.
6
LRR 24.125
0
8.22674
6
11.0000 35.0000
0
there was much difference between the inflation rate in a given
year and its mean which also means that there was a higher
variability of the general price levels. The maximum inflation
rate was 83.5 percent and the minimum inflation rate was 7.4
percent. The average annual exchange rate from 1980 to 2012 was
MK81.9 per United States dollar. The descriptive statistics
further indicates that Malawi economy experienced the highest
exchange rate value of MK334.6 and the minimum value was MK2.7
per United States dollar. The standard deviation of exchange rate
was at MK79 indicating that there was a high difference between
the mean exchange rate and the exchange rate in a given year.
During the specified period, the mean value of total money supply
in the Malawi economy was MK71112.9 thousand billion. The
statistics are further indicating that the maximum value of total
money supply per year was MK386435.6 billion and the minimum
money supply was MK732.1 billion. The standard deviation however
indicates that there was a higher variability between the total
money supply in a given year and the mean of money supply.
However the mean percentage of the reserve required ratio was
24.13 percent while it’s maximum and minimum percentage values
were 35 and 11 percent respectively.
5.2. Interpretation of Diagnostic Results
5.2.1 Testing for Serial Autocorrelation
Page39
To test for the presence of serial autocorrelation the study used
the Durbin Watson (D-statistics). Referring to Appendix A the
regression output indicates that the value of the Durbin Watson
is 2.26 indicating that there was no presence of serial
autocorrelation.
5.2.2 Testing for the Goodness of Fit
To find out whether the model is of a goodness of fit the study
used the R-squared value. Based on the value of R-Squared in
Table 4 the value of R-Squared was estimated to be 0.99
indicating that 99 percent of the variation in the dependent
variable is explained by its explanatory variable. This however
calls for the conclusion that the employed model significantly
fits the data in the sample.
5.2.3 Unit root Test
Unit root test results in the appendix B indicate that all the
employed variables were stationary at one percent significance
level, except the variable of Liquidity Reserve Required Ratio.
However the remedy that was taken to make it stationary was by
using the first difference operator.
5.3. Interpretation of Regression results
Table 3: Estimated Regression
Dependent Variable Gross Domestic Product
Variable Coefficient Standar t- P-Value
Page40
d Error Statisti
c
Constant 76.21861* 36.2104
8
2.104877 0.0505
Real GDP (-1) 0.645596*** 0.12030
5
5.366311 0.0001
INTEREST RATE -1.241429** 0.48957
9
-
2.535705
0.0213
EXCHANGE RATE 0.496541**
*
0.11373
0
4.365952 0.0004
LRR -1.704590** 0.66486
8
-
2.563802
0.0201
MONEY SUPPLY 0.000293** 0.00013
0
2.244822 0.0384
INFLATION RATE -0.653925* 0.32696
1
-
2.000008
0.0617
Sample Size
R-Squared
F-Statistic
Prob(F-
Statistic)
D-Statistic
32
0.99
281.3
0.0000
2.26
**** Indicates statistical significance based on p-values at 1%, ** statistical
significance at 5% and finally * indicates statistical significance at 10%.
Page41
The results in Table 4 are based on the detailed regression
output in appendix A. The value of F-Statistic in Table 4 is
281.3 with a p-value of 0.0000, indicating that jointly the
fitted explanatory variables are statistically significance to
the performance of economic growth in Malawi.
5.3.1. Interpretation of the regression parameters
Holding all other explanatory variables constant a percentage
increase of the lagged real GDP will result into an increase of
annual real GDP level by 0.645596. Statistically the variable of
the lagged real GDP is significant at 1 percent significance
level. This therefore means that there is a positive and also
strong relationship between lagged GDP and the GDP output in a
given year in Malawi. To determine the lags to be used in the
study, Alkaike Information Criteria (AIC). This criterion imposes
a penalty to the regression model when you add more lags. As a
result, when the study introduced another lagged variable of the
real GDP, the AIC was increasing. Therefore, the study only
adopted to use one year lagged variable in the dependent
variable.
Interest rate also indicates that holding all factors constant,
one percent increase in the level of interest rates will result
into a decrease of annual real GDP by 1.2414. This variable is
also statistically significant at 10 percent significance level.
This outcome indicates that interest rates have a strong and
negative correlation with real GDP output in Malawi.
Page42
The slope coefficient of exchange rate is positive, indicating
that holding all other variables constant a percentage of
exchange rate will result into an increase of real GDP by
0.496541. Furthermore the variables of exchange rate have also
been found to be statistically significant at 1 percent level of
significance. This also means that exchange rate is one of the
strong determinant of real GDP growth in Malawi.
The Liquidity Reserve Required Ratio has also been found to be
statistically significant at 5 percent level of significance.
Economically the slope coefficient of the Liquidity Reserve
Required Ratio is negative, indicating that a percentage increase
of LRR will result in a decrease of real GDP growth by 1.704.
The slope coefficient of money supply indicates that, holding all
variables constant a percentage increase of money supply in an
economy results into an increase of annual real GDP output by
0.000293. Statistically the variable of money supply indicates
that it is significant at 5 percent level of significance. This
will however call a conclusion that money supply is a strong
economic factor influencing GDP growth in Malawi.
Finally, the slope coefficient of inflation rate also indicates
that a percentage increase in the general price levels in Malawi
will result in a decrease of real GDP level 0.653925.
Page43
Statistically the variable of inflation rate also indicates that
it was statistically significant at 10 percent level of
significance.
Page44
CHAPTER SIX
CONCLUSION AND POLICY IMPLICATION
6.1. Summary of Results
This dissertation presents results of an empirical investigation
undertaken into the effects of monetary policy on economic growth
in Malawi. To achieve its objectives the study used time series
data obtained from the 1980 to 2012. The model employed was an
Autoregressive lagged model which allows the estimation of a
regression model in terms of its lagged dependent variable.
The main variables of interest were GDP growth, lagged GDP,
interest rate, exchange rate, inflation rate, money supply and
Liquidity Reserve Ratio. EVIEWS statistical software package was
used in order to conduct the diagnostic test and estimation of
parameters.
6.2. Outcome and Findings
The empirical findings of the study suggest that all the employed
explanatory variables which include: lagged GDP, interest rate,
exchange rate, inflation rate, money supply and Liquidity Reserve
Ratio statistically affects GDP growth in Malawi.
In summary the study has found out that a percentage increase of
the lagged GDP growth in Malawi results into an increase of
Page45
economic growth by 0.645596. Contrary to that the study has also
found out that one percent increase of interest rate by the
Reserve Bank of Malawi, results into a decrease of GDP growth by
1.2414. Furthermore, inflation rate, money supply and Require
Reserve Ratio were found to have a significant effect to real GDP
growth by -0.653925, 0.000293 and -1.704 respectively.
Overall, therefore, the results of the study indicate that there
is a strong relationship between monetary policy and economic
growth of Malawi and there is need for policy makers to pay a
particular attention to money supply, interest rate and liquidity
reserve ratio when deciding a policy to implement that would lead
to economic growth. This paper, in turn highlights to policy
makers areas to consider when designing monetary policies being
recommended or implemented appropriately, in order to ensure
effectiveness in fulfilling the intended objectives of growing
the economy.
6.3. Policy Implication of Results
The study therefore suggests that there should be regulations by
the Reserve Bank of Malawi in an attempt to reduce the interest
rates. This is based on the reason that interests rates has been
found to have a negative implication on economic growth, that in
the ends reduces overall private investment in the economy. The
study also advice the Government of Malawi should continue using
the floating exchange rate regime, since it allows the forces of
the market to determine the levels of exchange rate in an
Page46
economy. This policy implication advice has been enlightened
because exchange rate has been found to have a positive
implication on economic growth. In that way influencing the
performance of exchange rate to be increasing as it will be
determined by the economic market forces.
Finally, the study also advice the Government through the Reserve
Bank of Malawi, that it should be using all the necessary means
of increasing the level of money supply in the economy. However,
this policy implication is based on the reason that money supply
as one of the major objective of the Reserve Bank of Malawi in
controlling it has been found to have a positive effect to GDP
growth. It is therefore necessary that the expansionary monetary
policy should be applied, hence increasing the levels of money
supply in the Malawi economy.
6.4. Limitations of the Study
Although, it is hoped that the study will aid in provision of
literature aimed at highlighting on the different factors
affecting economic growth and different mechanisms that policy
makers may use in improving the performance of the country in
terms of economic growth, it is important to take into
consideration a number of shortfalls associated with data used in
this study.
Page47
Firstly, the study used annual data to investigate the effects of
monetary policy on the economic growth of Malawi. However, it
should be noted that some of the effects that monetary policy
posed on the economic grow of Malawi were temporary as such it
was essential to examine these effects using monthly data.
Secondly, the constant in the regression results shows that it is
statistically significant at 10%. This means that other variables
were omitted. The study omitted some relevant variables such as
unemployment rate due to unavailability of data as such the
results may be frail.
6.5. Area of Further Study
There are many factors that affect economic growth of a country
of which some of the factors are not outlined in this study as
such; areas of further study can be to investigate if fiscal
policy is positively affects economic growth of a country.
Another area of study associated with the current study is to
find out whether monetary policy can be used independently to
achieve economic growth in a country.
Page48
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Diamond, R. (2003) Irving Fisher on the international
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Journal of Money, Credit and Banking, Vol. 35 Pp 49 online
edition
Dornbusch. R., Fisher .S. 2004. Macroeconomics. 8th ed.
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Gondwe, S. (2001). The Impact of Liberalisation Policies on Commercial Bank
Behaviour and Financial Savings in Malawi. Zomba: Unpublished MA Thesis
Gujarati, D. N., (2004), Basic Econometrics, Fourth Edition, The
McGraw-Hill Companies, USA
Keynes, J. (1930) ‘Treatise on money’ London, Macmillan.
Kwalingana, S. C. (2007). A Monetary Policy Reaction Function for
Malawi.MA Thesis Zomba: Chancellor College
Lattie. C (2000). Monetary Policy Management in Jamaica. Bank Of
Jamaica. Available [Online] www.boj.org.jm
Mangani. R (2011). The Effects of Monetary Policy in Malawi.
Available [online] www.trapca.org/.../
Malawi Government. (1989). Reserve Bank of Malawi Act. Laws of Malawi ,
44 (02), 1-19
Mankiw G.2003,principles of macroeconomics. 3rd ed
Maturu, B. (2007). Channels of Monetary Policy Transmission in
Kenya. Unpublished Manuscript , 1-25.
Mishkin (2003). Economics of Money and Banking 7th Edition. New
York: Person Education Inc. Addison-wesley.
Page50
Ngalawa. H . (2009). Dynamic Effects of Monetary Policy Scocks in
Malawi. Availabe [online] www.africametrics.org
Sato L. J (2001). Monetary Policy Frameworks in Africa: The Case of
Malawi. September, 2001.
APPENDICES
Appendix A: RBM’S Monetary Policies Trends and their outcomes
Table 4: RBM’s Monetary Policies Trends and their Outcomes
Period Monetary Policy Exchange Rate Lending Real Inflatio
Page51
Policy F/work GDP
growt
h
n Rate
1964-1986
(Financial
Repression)
Interest rate
controls
Preferential
lending to
agricultural
sector
Price control
on selected
commodities
Fixed Exchange
Rate regime
Credit
controls
5.0 7.8
1987-1993
(Financial
Reforms)
1987-
deregulation
of lending
rates
1988-
deregulation
of deposit
rates
1989-Review of
the Banking
Act
1990-abolition
of
Pegged to a
basket of
currencies
Deregulat
ed
lending
3.3 19.0
Page52
preferential
lending rates
1994-2007
(financial
liberalizatio
n)
Indirect
Monetary
Policy
instruments:
Discount rate,
OMO, LRR
New commercial
banks entered
the system
Free float
Partial
deregulation of
exchange
controls
establishment
of foreign
exchange bureau
establishment
of FCDA
establishment
of foreign
exchange
market,
Deregulat
ed
lending
3.2 30.4
2008-April
2012:
liberalized
financial
sector)
Indirect Monetary
Policy instruments:
Discount rate, OMO,
LRR
Defacto fixed
exchange Rate
with
administrative
controls over
current account
Deregulat
ed
lending
6.0 10.4
Page53
transactions
May 2012- to
date;
(liberalized
fin. sector)
Indirect Monetary
Policy instruments:
Discount rate, OMO,
LRR
Free float with
liberalized
current account
transactions
Deregulat
ed
lending
1.6 20.1
Source: Chuka, 2012
Appendix B: Regression ResultsDependent Variable: GDPMethod: Least SquaresDate: 07/26/13 Time: 15:14
Page54
Sample(adjusted): 1989 2012Included observations: 24 after adjusting endpoints
Variable Coeffici
ent
Std.
Error
t-
Statistic
Prob.
C 76.21861 36.21048 2.104877 0.0505GDP(-1) 0.645596 0.120305 5.366311 0.0001INTEREST -
1.241429
0.489579 -2.535705 0.0213
EXCHRATE 0.496541 0.113730 4.365952 0.0004LRR 1.704590 0.664868 2.563802 0.0201MONEYSS 0.000293 0.000130 2.244822 0.0384INFLATION 0.653925 0.326961 2.000008 0.0617
R-squared 0.990030 Mean dependent
var
410.500
0Adjusted R-
squared
0.986512 S.D. dependent
var
132.424
2S.E. of
regression
15.37961 Akaike info
criterion
8.54245
4Sum squared
resid
4021.048 Schwarz
criterion
8.88605
4Log likelihood -
95.50945
F-statistic 281.364
7Durbin-Watson
stat
2.260182 Prob(F-
statistic)
0.00000
0
Appendix C: Test for Stationarity
ADF Test 4.31329 1% Critical -3.6496
Page55
Statistic 4 Value* 5% Critical
Value
-2.9558
10% Critical
Value
-2.6164
*MacKinnon critical values for rejection of
hypothesis of a unit root.
Augmented Dickey-Fuller Test EquationDependent Variable: D(GDP)Method: Least SquaresDate: 07/26/13 Time: 15:18Sample(adjusted): 1981 2012Included observations: 32 after adjusting endpoints
Variable Coeffici
ent
Std.
Error
t-
Statistic
Prob.
GDP(-1) 0.157332 0.036476 4.313294 0.0002C -
37.23965
13.40364 -2.778323 0.0093
R-squared 0.382773 Mean dependent
var
17.6250
0Adjusted R-
squared
0.362199 S.D. dependent
var
29.9362
2S.E. of
regression
23.90780 Akaike info
criterion
9.24674
8Sum squared
resid
17147.48 Schwarz
criterion
9.33835
6Log likelihood -
145.9480
F-statistic 18.6045
1Durbin-Watson
stat
1.978084 Prob(F-
statistic)
0.00016
0
Page56
ADF Test
Statistic
-
4.470822
1% Critical
Value*
-3.6576
5% Critical
Value
-2.9591
10% Critical
Value
-2.6181
*MacKinnon critical values for rejection of
hypothesis of a unit root.
Augmented Dickey-Fuller Test EquationDependent Variable: D(INTEREST,2)Method: Least SquaresDate: 07/26/13 Time: 15:20Sample(adjusted): 1982 2012Included observations: 31 after adjusting endpoints
Variable Coeffici
ent
Std.
Error
t-
Statistic
Prob.
D(INTEREST(-1)) -
0.855975
0.191458 -4.470822 0.0001
C 0.469933 1.390881 0.337867 0.7379
R-squared 0.408021 Mean dependent
var
0.38709
7Adjusted R-
squared
0.387608 S.D. dependent
var
9.89504
1S.E. of
regression
7.743410 Akaike info
criterion
6.99390
2Sum squared
resid
1738.851 Schwarz
criterion
7.08641
7Log likelihood -
106.4055
F-statistic 19.9882
5
Page57
Durbin-Watson
stat
1.825620 Prob(F-
statistic)
0.00011
0
ADF Test
Statistic
-
3.280633
1% Critical
Value*
-3.6496
5% Critical
Value
-2.9558
10% Critical
Value
-2.6164
*MacKinnon critical values for rejection of
hypothesis of a unit root.
Augmented Dickey-Fuller Test EquationDependent Variable: D(INFLATION)Method: Least SquaresDate: 07/26/13 Time: 15:21Sample(adjusted): 1981 2012Included observations: 32 after adjusting endpoints
Variable Coeffici
ent
Std.
Error
t-
Statistic
Prob.
INFLATION(-1) -
0.526767
0.160569 -3.280633 0.0026
C 10.83528 4.072669 2.660485 0.0124
R-squared 0.264030 Mean dependent
var
0.17500
0Adjusted R-
squared
0.239498 S.D. dependent
var
15.9257
3S.E. of
regression
13.88831 Akaike info
criterion
8.16043
4
Page58
Sum squared
resid
5786.555 Schwarz
criterion
8.25204
2Log likelihood -
128.5669
F-statistic 10.7625
5Durbin-Watson
stat
1.869419 Prob(F-
statistic)
0.00262
9
ADF Test
Statistic
2.72171
1
1% Critical
Value*
-3.6496
5% Critical
Value
-2.9558
10% Critical
Value
-2.6164
*MacKinnon critical values for rejection of
hypothesis of a unit root.
Augmented Dickey-Fuller Test EquationDependent Variable: D(EXCHRATE)Method: Least SquaresDate: 07/26/13 Time: 15:23Sample(adjusted): 1981 2012Included observations: 32 after adjusting endpoints
Variable Coeffici
ent
Std.
Error
t-
Statistic
Prob.
EXCHRATE(-1) 0.209193 0.086382 2.421711 0.0217
Page59
C -
0.324400
6.702323 -0.048401 0.9617
R-squared 0.163523 Mean dependent
var
10.4293
8Adjusted R-
squared
0.135640 S.D. dependent
var
30.5456
5S.E. of
regression
28.39859 Akaike info
criterion
9.59101
7Sum squared
resid
24194.39 Schwarz
criterion
9.68262
6Log likelihood -
151.4563
F-statistic 5.86468
6Durbin-Watson
stat
1.279077 Prob(F-
statistic)
0.02170
3
ADF Test
Statistic
-
6.989260
1% Critical
Value*
-3.7667
5% Critical
Value
-3.0038
10% Critical
Value
-2.6417
*MacKinnon critical values for rejection of
hypothesis of a unit root.
Augmented Dickey-Fuller Test EquationDependent Variable: D(LRR,2)Method: Least SquaresDate: 07/26/13 Time: 15:24
Page60
Sample(adjusted): 1991 2012Included observations: 22 after adjusting endpoints
Variable Coeffici
ent
Std.
Error
t-
Statistic
Prob.
D(LRR(-1)) -
1.355038
0.193874 -6.989260 0.0000
C -
0.131924
1.064906 -0.123883 0.9026
R-squared 0.709512 Mean dependent
var
-
0.40909
1Adjusted R-
squared
0.694988 S.D. dependent
var
9.03779
9S.E. of
regression
4.991386 Akaike info
criterion
6.13981
2Sum squared
resid
498.2787 Schwarz
criterion
6.23899
8Log likelihood -
65.53793
F-statistic 48.8497
5Durbin-Watson
stat
1.889622 Prob(F-
statistic)
0.00000
1
ADF Test
Statistic
21.6896
5
1% Critical
Value*
-3.6496
5% Critical
Value
-2.9558
Page61
10% Critical
Value
-2.6164
*MacKinnon critical values for rejection of
hypothesis of a unit root.
Augmented Dickey-Fuller Test EquationDependent Variable: D(MONEYSS)Method: Least SquaresDate: 07/26/13 Time: 15:27Sample(adjusted): 1981 2012Included observations: 32 after adjusting endpoints
Variable Coeffici
ent
Std.
Error
t-
Statistic
Prob.
MONEYSS(-1) 0.279057 0.012866 21.68965 0.0000C 528.0600 1092.195 0.483485 0.6323
R-squared 0.940053 Mean dependent
var
12070.5
5Adjusted R-
squared
0.938055 S.D. dependent
var
21677.9
0S.E. of
regression
5395.373 Akaike info
criterion
20.0849
3Sum squared
resid
8.73E+08 Schwarz
criterion
20.1765
4Log likelihood -
319.3589
F-statistic 470.441
1Durbin-Watson
stat
2.077399 Prob(F-
statistic)
0.00000
0
Page62
Appendix D: Unit Root Test Results
Variable Stationary
Critical level
Difference
Operator
GDP 1 percent None
Lagged GDP 1 percent None
Interest Rate 1 percent None
Exchange Rate 1 percent None
Money Supply 1 percent None
LRR 1 percent First
Inflation 1 percent None
Page63