1.1  Background,  Objective  of  the  study  and  Significance  of  the study 

One of the macroeconomic challenges facing government in Madagascar has been the maintenance of the price stability. According to Jean paul Azam (2001) [1], the rate of  inflation  is  the  crucial  proximate  factor  of  the  macroeconomic  instability  in Madagascar.  even  though  Government  and  policy  makers  have  recognized  the seriousness of the phenomenon in the economy, and have developed policies to combat it,  surprisingly,  inflation  is  still  uncontrollable.  There  has  not  been  any  remarkable success  due  to  various  constraints  and  problems  such  as  the  political  instability,  the instability of the MGA (Malagasy Ariary: currency of Madagascar)?s exchange rate, the increased fiscal deficit, and the inadequate policy implementation and coordination.   Milton Friedman(1963) [2], the father of monetarism and laureate of the Nobel prize in  economics,  declared  that  “Inflation  is  always  and  everywhere  a  monetary phenomenon” and argued that the changes in overall price level are only brought about by  the  changes  in  monetary  stock  or  money  supply.  Influence  of  changes  in  money supply  over  price  level  is  a  subject  of  controversy.  For  decades,  the  study  of  the monetary  economy  of  a  country  has  always  represented  an  attractive  topic  for researchers.  Despite  several  years  of  researches,  the  predicted  relationship  between money and inflation remains disputed in developed countries as well as in developing countries. Given the important role that plays inflation (or the price stability) in the economic development of Madagascar, and the predicted link between the money supply and the inflation, it is pertinent to analyze the relationship between the money supply and the inflation in Madagascar.  This research study makes an attempt to study the relationship between the rate of growth in money supply and rate of inflation in Madagascar, over the period 1992-2012, with an  empirical analysis  conducted using a linear regression  model. The  estimated model is using data such as the inflation rate, the money supply, and the exchange rate) sourced  from  the International  Monetary Fund?s International  Financial  Statistics, the national  institute  of  statistics  (INSTAT)  in  Madagascar  and  the  Central  Bank  of Madagascar.  

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1.2  Literature review 

Most of the time, inflation is informally described as “too much money chasing too few  goods”.  This  statement  captures  important  aspects  of  why  the  money  growth  is linked  to  the  inflation.  Still,  e.  J.  Hamilton  (1993) [3],  defines  the  inflation  as  an economic  situation in  which  the increase  in  the  money  supply is  faster than  the  new production of new goods and services in the same economy.  According to M. C. Vaish (2002) [4], inflation is a sustained increase in the general price  level  caused  by  an  elevated  rate  of  expansion  in  the  aggregate  money  supply. Inflation emerges in the economy on account of the rise in the money income of certain sectors of the economy without any corresponding increase in their productivity, leading to an increase in the aggregate demand for goods and services which cannot be met at the current prices by the total available supply of goods and services in the economy.  Generally, money supply is defined as the whole amount of money existing or in circulation in a country. In other words, the money supply is, as of a particular time, the total stock of currency and other liquid instruments that households and firms can use to make a payment, or to hold as short-term investments in a country?s economy.  The relationship between money supply and inflation is a very common debate in the economic literature. Many economists have analyzed the relationship among these variables over many years.  At  international  level,  such  studies  include  A.  J.  Chhibber  et  al.  (1998) [5]  that employed a highly disaggregated  econometric  model  for  Zimbabwe. 

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Chapter 2 Theoretical Research and Foundation 

 

2.1  The concept of the inflation and the money supply

They  found that the key determinants of inflation in that country are the monetary growth, the foreign price, the exchange and interest rates, the unit labor cost, and the real output. In a study for the African economic Research Consortium (AeRC), A. L. Kilindo (1997) [6] tried to enlarge our understanding of the inflation in Tanzania by scrutinizing the  links  between  the  fiscal  operations,  the  money  supply  and  the  inflation.  Having found a strong relationship among the three variables, he recommended the adoption of a more restrictive monetary policy in which the supply of money should be constrained to grow steadily at the rate of growth of reThe word ?Inflation? comes from the Latin “Inflatio’. It means increase, dilatation, expansion or blown up (Dictionary of economic Sciences, 2000) [32]. In most countries, the general level of prices tends to increase over time. This phenomenon is known as Inflation. Inflation means a sustained increase in the general price level of goods and services in an economy over a period of time.  Inflation is an  economy-wide  phenomenon that  concerns,  first and  foremost, the value of the economy?s medium of exchange. When the general price level rises, people have to pay more for goods and services. In another words, each unit of currency buys fewer goods and services. Alternatively, the price level can be viewed as a measure of the  value  of  money.  This  implies  that  an  increase  in  the  price  level  means  a  less significant value of money that is the quantity of goods and services a given amount of money  can  buy decreases or a  reduction in  the purchasing  power  per unit  of  money which is a loss of real value in the medium of exchange and unit of account within the economy.     Inflation is a continuous and sustained increase in the general prices of goods and services. Hence a one-time increase in the general price level cannot be classified as an inflation because it is expected to stabilize after their one-time leap. In another words, with no continuing expansion in the quantity of money, there can be no inflation. This is what  Milton Friedman  meant  by  his  memorable aphorism “inflation is  everywhere a monetary phenomenon.”  Ludwig von Mises (1912) [33], a major figure in the Austrian school of economics, argued  that  inflation  did  not  describe  rising  prices  at  all,  but  actually  described  an increase in the money supply. He supports that when a central bank, such as the Federal Reserve, performs open-market operations to increase the money supply in an economy, the  extra  money  will  be  invested  in  an  attractive  sector  of  the  economy.  This  will increase the prices in this sector and eventually throughout the economy. Unfortunately, the price increases do not represent an increase in real value, which means there will be an eventual "bust" to the investment bubble. 

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2.2  Theories of inflation 

Some  of  the  most  frequently  cited  factors  influencing  inflation  are  those  linked with the exchange rate management, or those that are monetary in nature and highlight the  importance  of  the  money  supply  and  of  policies  to  control  the  expansion  of  the money supply. Other models focus on structural factors, such as market imperfections  and cost pressure from import price, whilst other  emphasize demand pressures such as the government expenditure or the cost of government services, the amount of revenue collected , etc.  Greene (1989) [37] has reviewed several approaches used to shed more lights on the inflation in African countries. The author classified then into: (a) monetarist approaches, (b) those that focus on the role of exchange rate depreciation either in conjunction with monetary policy or as influence on other factors feeding into the inflation, and (c) those centered on the fiscal model, more specifically on the fiscal deficits as the main cause of the monetary expansion.  al output. 

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Chapter 3 Monetary policy framework in Madagascar ......... 18

3.1  Background of the Malagasy economy........ 18 

3.2  Monetary policy framework ........ 21 

3.3  Chapter summary ....... 26 

Chapter 4 empirical Analysis of the Money Supply and Inflation in Madagascar ........ 27

4.1.  Methodology ..... 27 

4.2.  Variables and Data ..... 28 

4.3.  empirical resuls .......... 28 

4.4.  Verification and explanation of Hypotheses ........ 32 

4.5.  Discussions and Implications ...... 36 

4.6.  Recommendations for Future Research ........ 36 

4.7.  Limitations of the Research ......... 37 

4.8.  Chapter summary ....... 37 

 

Chapter 4 empirical Analysis of the Money Supply and Inflation in Madagascar 

 

4.1.  Methodology 

In this research study, we used secondary data collected from the National Institute of  Statistics  (INSTAT)  in  Madagascar,  the  World  Bank  data  base,  and  at  last,  the Central  Bank  of  Madagascar  for  the  period  between  the  years  1992-2012.  The  data gathered consists of the monthly observations for each variable from the year 1992 to 2012.  In analyzing the collected data, the correlation coefficient - a quantitative measure that  determines  the  degree  to  which  two  variable?s  movements  are  associated,  is expected to be exploited. It is hoped that positive significance will turn out to be the outcome, wherein r is expected to have a positive correlation.pearson?s  correlation coefficient is the  test statistics that  measures the  statistical relationship, or is the association between two continuous variables.  It is known as the best  method  of  measuring  the  association  between  variables  of  interest  because  it  is based on the method of covariance.  It gives information about the magnitude of the association, or correlation, as well as the direction of the relationship. The mathematical formula for computing r is as followed: 

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Conclusion 

 

In this  dissertation  regarding  the relationship  between  the  money  supply  and  the inflation  in  Madagascar,  with  the  aim  of  finding  the  extent  of  how  the  monetary expansion can influence the price level, the researcher therefore conclude that: 

(1) The multiple linear regressions method was used in the analysis of the stated influencing  factors;  it  was  proven  that  the  more  the  money  supply  increase  in  the country, the  greater  bigger  chance to  experience inflation in  the Malagasy  economy. With the use of pearson?s correlation coefficient in finding out the level of impact the money supply on the price level in Madagascar, it has been found that there exists a strong and  positive  correlation  between the variables. The  money  supply is therefore playing  a  significant  role  not  only  on  the  price  level,  but  also  on  the  economic performance  of  the  country  since  the  price  stability  is  a  crucial  determinant  of  the economic stability in less developed countries.  

(2) It was also found through the use of the linear regression method analysis and the  pearson?s  correlation  coefficient  that  the  Real  exchange  rate  has  also  a  positive impact  on  the  inflationary  process,  even  though  the  correlation  between  them  less significant compared to that of the money supply and the inflation in Madagascar. 

(3)  Though  the  relationship  between  the  variables  have  been  confirmed  by  the correlation  coefficient  method,  it  can  not  help  to  determine  if  the  relationship  in question is a causal relationship or not. (4)  The  study  suggested  policies  which  aimed  at  properly  formulating  and implementing good monetary policies for a better control of the monetary expansion as well as a better management of the exchange rate.  It is, therefore, recommended that constraining the growth in  money  supply,  while  maintaining a  sustainable amount  of money in the economy, should continue to be of paramount interest to the Central Bank of Madagascar, and the policy makers as whole. 

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The reference (omitted)