Malawi’s trilemma: monetary policy independence, exchange rate stability and financial integration

Malawi has, in the last few decades, undergone several reforms relating to monetary, exchange rate and financial integration policies in a bid to achieve sustainable economic growth. Despite these reforms, however, the country has barely attained desirable macroeconomic performance. This study sets out to establish if the need for these policy reforms is due to the fact that the country is constrained from the simultaneous achievement of optimal levels of monetary policy independence, exchange rate stability and financial integration, as postulated by the ‘trilemma’. The trilemma is evaluated using an approach introduced by Aizenman et al. (2008), in which the Ordinary Least Squares (OLS) method is applied to a model in which a constant is regressed on indices constructed for the policy intermediate goals; the results indicate that the trilemma is a binding constraint in Malawi and that the largest trade-off is between exchange rate stability and financial integration. Given these constraints, the study also considers the combination of the trilemma intermediate policy goals that has been dominant in the country in the last three decades, using predicted values from the model and a graphical analysis to explore this objective. The analysis reveals that Malawi has, on average, prioritised exchange rate stability and monetary policy independence at the expense of financial integration. The study also assesses how the trilemma intermediate policy goals affect macroeconomic performance, specifically regarding output growth rate and inflation. The results reveal that exchange rate stability is associated with faster output growth, financial integration is associated with higher inflation, and that monetary policy independence is not a significant factor. The results emphasise the importance of consistent stability of the exchange rate if Malawi is to achieve faster and sustainable economic growth. Given this, policy makers must be cautious, as the current floating exchange rate regime, combined with financial integration, could lead to slow growth and high inflation