Inflation and the Role of Macroeconomic Policy in Ethiopia

Abstract

The recent historical evidence indicated that Ethiopia has suffered from high inflationary experience owing to weather shocks (drought) and conflict (war). Despite its sustained economic growth and one of the fastest growing non-oil producing economies in Africa, the country had experienced soaring inflation distorting allocation of resources and deterrent to undertaking productive investments. In effect, households in Ethiopia especially urban poor were badly hurt and still the problem persist all over the country. This paper has critically reviewed the trends, the main causes and consequences of inflationary pressure and the role of macroeconomic policy in Ethiopia. The result showed that the magnitude of inflation in Ethiopia was found to be very high and the trends of inflation in Ethiopia seem to continue. Four main causes of inflation in Ethiopia were identified. The result concur with theories of inflation as an economic growth phenomenon, demand-pull and cost-push theories of inflation, the monetarist explanation of the causes of inflation, and fiscal budget deficit as the main source of inflation. Moreover, some oligopolistic pricing by few distributors/traders in Ethiopia was also identified as the major determinant of inflation. This implies the presence of monopoly power/market failure in price formation. To this end, the Ethiopian government has adopted various fiscal and monetary policy measures to control and mitigate the adverse effects of inflation in the country. A mix of monetary policy instruments such as adjusting reserve requirement and interest rates, and sale and purchase of bonds have been implemented for lessening the effect of inflation and better performance of the economy. However, the effectiveness of these policies in achieving the intended goal largely depends on the institutional factors that constrain the implementation process of the policy. To contain inflation, therefore, the government needs to exercise conservative fiscal and monetary policies measures.

Keywords: Inflation, fiscal and monetary policies, Ethiopia