How monetary policy affects industrial activity in Malawi: Evidence from ARDL and VAR models

Abstract

In this paper, the impact of monetary policy on industrial production is investigated for Malawi. Using the ARDL bounds testing approach, and VAR models, it is shown that tight monetary conditions negatively affect industrial production both in the short run and in the long run. This is the case whether the central bank’s policy rate or reserve money is used as the policy tool. The study further establishes the interest rate channel, and money supply channel as the main mechanisms through which this effect of monetary policy is transmitted to industrial production. Given these results, a recommendation is made that the Reserve Bank of Malawi should refrain from prolonged use of tight monetary policy in their quest to achieve stability of prices as this stifles growth of the industrial sector. Rather monetary policy should be used as a temporary stabilization tool when faced with temporary shocks to the bank’s policy objectives.

Keywords:

• monetary policy
• industrial production
• autoregressive-distributed lag, vector autoregression

JEL Classification:

• E50
• E52
• E60

Public Interest Statement

The Reserve Bank of Malawi (RBM) conducts monetary policy aimed at achieving macroeconomic stability in Malawi. This is done by adjusting interest rates and money supply to affect the country’s output, prices, and exchange rate. However, the high interest rates as the RBM pursues low inflation negatively affects industrial activity thus raising questions about the appropriateness of the RBM’s monetary policies. This study confirms that tight monetary policy by the RBM negatively affects the industrial sector in Malawi both in the short run and in the long run, and recommends that the RBM refrains from prolonged use of monetary policy as tools for tackling structural inflation.

Disclosure statement

No potential conflict of interest was reported by the author.

Notes

1. The industrial sector is one of the areas prioritized in the Malawi Growth and Development Strategy.

2. Medina et al. (2017) estimates the that the informal sector contributes between 20 percent and 40 percent of Malawi’s GDP. Furthermore, according to the 2013 Malawi Labour Force Survey report, up to 89 percent of employed people in Malawi worked in the informal sector.

3. Per IMF’s definition, the industrial sector aggregates three activities from the International Standard Industrial Classification of All Economic Activities (ISIC) namely: manufacturing, mining and quarrying, and electricity and water supply.

4. See the Annual Economic Reports for 2019 and years before for sectoral shares of GDP and other national accounts information.

5. John B. Taylor was an economic adviser to US president George H. W. Bush. He proposed the rule in 1992 for the US Federal Reserve Bank to use in setting interest rates to stabilize prices and output.

6. The sample period reflects data availability particularly for industrial production index. Currently, Malawi’s industrial production index data in the IFS is updated with a 4 year time lag. At the time of the analysis the data was available only up to 2016/07. The last two observations are not included in our analysis because they cause instability of the VAR models. Nevertheless, including them does not affect the estimation results in terms of size and significance of parameter estimates.

Additional information

Notes on contributors

Joseph Upile Matola

Joseph Upile Matola is an experienced economist who has worked as Principal Economist for Ministry of Economic Planning and Development in Malawi, specializing in macroeconomic policy analysis. He holds a Ph.D. in Development Economics from the National Graduate Institute for Policy Studies in Japan where he researched on various aspects of Malawi’s fiscal and monetary policies. He has also worked with the South African Institute of International Affairs where he has analyzed the macroeconomic impact of COVID-19 on 6 low- and middle-income countries in Africa.