The Role of Exchange Rate and Monetary Policy in the Monetary Approach to the Balance of Payments: Evidence from Malawi

"This study has attempted to examine the relevance of the monetary approach to the balance of payments (MABP) using Malawi as a case study. Of particular interest is the overall balance of payments effects of the exchange rate, relative prices and domestic credit within the reserve flow equation (REF) variant of the MABP. Both quarterly and annual data sets were used in the investigations. No restrictions were imposed on the parameters of the regressors except on the dependent variable and for the small sample nature of annual data. This over-parameterization allowed us to report both the expected and perverse results from the MABP perspective. Price components seem to exhibit significant lagged impact on the overall BOP. The MABP's postulate of a unitary elasticity for the domestic price level was confirmed using quarterly data with a coefficient of 1.06 achieved in two quarters. In a number of cases, however, the coefficients switch signs, sometimes at different intervals. The BOP impact of the non-tradables price was found to be stronger from the relative price side than from the money demand side as the negative coefficients persisted up to year three. From the point of view of relative prices there are indications that a mismatch of traded and non-traded goods price movements exists which could have resulted from misalignment of incentives. The negative coefficients which tend to precede positive ones for the NER and the RER on annual and quarterly series, respectively, suggest initial deflationary effects of devaluation."