Do Prices Influence Economic Growth? Estimating the Inflation Threshold of the Ethiopian Economy

Abstract

The study empirically examines the relationship between changes in the general price and economic growth in Ethiopia. The relevant macroeconomic variables are used in a quarterly dataset from 1992Q1 to 2015Q4 obtained from the National Bank of Ethiopia (NBE), Central Statistics Agency (CSA) , Ministry of Finance and Economic Corporation (MoFEC) and an international data sources including World penn Table and World Development Indictors (WDI). In assessing the relationship between prices and economic growth, an interesting policy issue arises. What is the threshold level of inflation for the Ethiopian economy? Real GDP growth used as a proxy for economic growth and general prices measured using the consumer price index (CPI), the study uses the Conditional Least Square (CLS) technique employed by Khan and Senhadji (2000). The estimation result suggests that 10% as the optimal level of inflation that facilitates economic growth. An inflation level higher than the estimated threshold level will affect the growth of the real GDP negatively. Likewise, if inflation rate is below the threshold level, it hurts the economy as real GDP could have grown more since inflation is positively related below the threshold point. Therefore, fiscal and monetary policy coordination is vital to keep inflation at its threshold level. This finding is useful for macroeconomic policy makers at the central bank as a guide for inflation targeting monetary policy.

Keywords: Economic Growth, consumer price index, Conditional Least Square