A study conducted by Ronald Mangani, an associate professor of economics at University of Malawi’s Chancellor College, has concluded that the country’s monetary policy is not effective in stabilising prices and growing the economy.
In a study titled ‘The effectiveness of monetary policy in Malawi: Further evidence and policy implications,’ Mangani revealed that it is the exchange policy that impacts on prices in the short run and real output in the long run.
Monetary policy is a process by which a monetary authority, usually a central bank of a country, controls the quantity of money in circulation for the purpose of attaining stability and economic growth objectives in an economy.
Generally, RBM uses two monetary policy tools of bank or discount rate and the Liquidity Reserve Ratio (LRR), although at times the central bank uses other tools.
“The research findings indicate that monetary policy is not effective in impacting on prices and real output. But exchange rate policy and, in particular, changes in exchange rate are the ones that impact on prices in the short run and real output in the longrun,” said Mangani in an interview with Business News.
The findings come at a time authorities are grappling to bring down inflation—currently at 22.5 percent as of June 2014 according to National Statistical Office (NSO) — back to single-digit lane despite executing tight monetary policy.
Mangani explained that in Malawi, the limited available literature suggests that there is no compelling evidence that monetary policy is effective in terms of achieving price stability or growth.
“In the short run, changes in money supply are transferred to the exchange rate which in turn impacts on prices. In the long run, domestic currency depreciation is pro-growth and it may be argued that the effect of the exchange rate on price in the short run is attributable to the exchange rate channel of monetary policy transmission mechanism,” he explained.
Mangani said in Malawi, consumer prices respond weakly to monetary impulses with the exception of exchange rate shocks, suggesting that inflation in Malawi may not be predominated by monetary factors.
He said although the lending rate directly responds to bank rate adjustments and that the lending rate somewhat influences money supply, the effects are not transmitted to prices or real output.
Commenting on exchange rate policy in Malawi, Mangani said the regime that government decides to implement is a challenge, saying fixing the currency on the foreign market leads to excessive external imbalances and eventually leads to unsustainable fixed exchange rate system.
He said such a situation culminates into big devaluations and eventually distorts the economy.
On one hand, Mangani said a flexible exchange rate system is a difficult regime to sustain in an economy where the accumulation of reserves is a huge challenge.
“Therefore, there is need for the authorities to balance between the two because management of the exchange rate within a reasonable band that is commensurate with the available reserves, but at the same time mix short-term and medium-term objectives of contacting inflation and achieving growth will be more appropriate,” he said.