The Introduction of Higher Banknotes and Inflation in Malawi : A Test of Bi-Causality - Research

Price instability is one of the factors that have hindered economic growth and development in Malawi. Research has shown that inflation is influenced by numerous factors in the real and monetary sectors. This study aimed to determine the relationship between inflation and the introduction of higher banknotes in Malawi. The main objective was to determine if the introduction of higher banknotes influences inflation and the magnitude of change in inflation that followed each of the denominations introduced after 1990. In Malawi, the introduction of new denominations is a monetary operation done by the Reserve Bank of Malawi (RBM). To achieve the objectives, the study employed the Vector Autoregression (VAR) model to test for the existence of feedback effects between inflation and currency denomination while an Ordinary Least Squares (OLS) model was used to find the impact of each of the new denominations on inflation. The study used monthly time series data from 1990 to 2017 in both models. The Granger causality Wald test results indicated strong evidence of a bi-directional relationship between inflation and higher banknotes as some of the denominations had a positive and significant impact on inflation. The implication of these results is that a change in the structure of money supply in terms of the mix of denominations can influence prices even when the level of money supply is constant. It is recommended that there should be a strategic introduction of higher denominations to avoid any inflationary impact. For instance, ensuring that the proportion of higher denominations is smaller than that of small denominations can help reduce inflationary expectations among the people when the RBM intends to introduce notes with a higher face value.