Despite consecutive years of good harvest, Malawi has experienced continuous price escalation of staple food commodities unsolved over the time. The real price of maize in Malawi has increased by 141 percent between 1998 and 2008, and has been rising along with the food prices of many other commodities over this period. This study therefore investigates the determinants of food inflation rate in Malawi and its effect on the economy. Monthly and annual data were collected from National Statistical Office and Reserve Bank of Malawi from 1978 to 2008. Data were analyzed by estimating an error correction model (ECM). The results show that fertilizer prices, crop diversification index, maize prices, diesel prices, real exchange rates and real interest rates significantly and positively influenced the rate of food price inflation in Malawi. In addition, the annual rate of food inflation, exports, imports, real interest rate and real exchange rate significantly influenced real agricultural output (GDP) and national GDP at 1 and 5 percent levels respectively. Furthermore, high food price inflation induced low purchasing power to consumers thereby reducing expenditure on consumable goods. Real national output (GDP) and agricultural GDP were negatively affected by food price inflation. The study recommends that a deliberate policy is needed to promote crop diversification in order to reduce food inflation emanating from monotonic food products. Policy makers also need to review exchange rate policy and move towards flexible exchange rate regime (e.g. crawling peg).