Trade Openness, Monetary Policy Shocks, and Welfare in Malawi: A Structural VAR Approach.

Redson Mwandama, Martin Munthali , Steven Henry Dunga, Dadirai Mkombe

Small open economies face complex interactions between external trade dynamics and domestic monetary policy. For Malawi, persistent inflation, exchange rate instability, and dependence on primary commodity exports raise important questions about the relative roles of trade openness and monetary policy in shaping welfare outcomes. This study examines how trade and monetary shocks affect welfare, proxied by GDP per capita, and identifies which source of disturbance dominates welfare fluctuations. Using annual data from 1981–2024 sourced from the World Bank’s World Development Indicators, the study employs a Structural Vector Autoregression (SVAR) framework. Variables include trade openness, inflation, real interest rates, and log GDP per capita. Stationarity is tested using Clemente-Montañés-Reyes and Augmented Dickey-Fuller procedures. A VAR (1) model is selected based on information criteria, and identification restrictions follow a recursive structure in which trade openness is treated as the most exogenous variable. Impulse response functions and forecast error variance decomposition (FEVD) are used to evaluate dynamic effects. The results show that trade openness shocks generate an initial positive response in welfare growth, followed by a short-lived negative adjustment before convergence to equilibrium. Monetary policy shocks exhibit negligible and statistically insignificant effects on welfare across horizons. Variance decomposition shows that trade shocks explain approximately 15-20% of welfare fluctuations, while monetary policy shocks account for less than 5%. In conclusion welfare dynamics in Malawi are predominantly driven by external trade disturbances rather than domestic monetary innovations. Strengthening export diversification and structural resilience may therefore yield greater welfare gains than reliance on conventional monetary policy tools alone.