Macroeconomic Effects of Commodity Price Shocks in a Low Income Economy: The Case of Tobacco in Malawi

One of the major concerns facing developing economies is the implications of their dependence on commodities and the implications of price changes. Considerable literature has developed from earlier work on the macroeconomic impact of oil price shocks in developed economies that have exploitable reserves. For developing economies, the implications of commodity prices can be much more profound. Commodity price shocks can become major macroeconomic concerns and a major reduction in the international commodity price can lead to a devastating slowdown in economic growth. While some cross country studies exist, there is lack of country specific studies that take into account the different characteristics of low income economies. This paper contributes to the growing literature by considering the case of Malawi and the macroeconomic impact of price shocks in its major export crop of tobacco. Using a Structural Vector Auto-regression (SVAR) approach on quarterly Malawian data from 1980:1 to 2012:4, the paper establishes that a positive tobacco price shock has a significant positive impact on the country's gross domestic product (GDP). This also decreases consumer prices and induces real exchange rate appreciation. The results are robust to alternative specifications of a SVAR on difference stationary data and co-integrating VAR. The co-integrating VAR confirms the existence of a long run-relationship among the variables and causality runs from tobacco prices.