Abstract

The objective of the paper is to assess whether financial reforms have a statistically significant effect on Malawi consumption behaviour. More specifically, the paper examines the existence of Permanent Income Hypothesis (PIH) and assesses whether the reforms have affected consumption behaviour by reducing liquidity constraints using Instrumental Variable and Two Stage Least Squares (IV-TSLS) approach. The paper finds that the PIH does not hold in Malawi and most consumers are current income consumers. They consume from “hand to mouth” and very little is left to smooth consumption in their life time. Empirical evidence from the thesis shows that the main failure of the PIH hypothesis is due to liquidity constraint which is manifested in the under development of the financial market and unstable macroeconomic conditions in Malawi. Weak financial institutions, both structural and operational have impacted negatively on the accessibility of financial resources for most Malawians despite the reforms. This is a bigger lesson for policy makers to consider in the preparation of future broad based financial reforms.

Key words: Financial liberalisation, permanent income hypothesis, linear spline function, principal component analysis, rule-of-thumb.