The Dynamics of Inflation in Ethiopia: Time Series Approach

Abstract

One of the prime objectives of governments is achieving stable macroeconomic condition. This objective requires that prices be kept to a reasonably stable level. High and persistent inflation introduces uncertainties into the economy and may lead to slowdown of economic growth by discouraging domestic as well as foreign investments. It may also cause balance of payments problems by eroding a country’s competitive advantage. Moreover, because it hits the poor the most it needs to be tackled. This study aims at understanding the forces behind the current inflationary process in Ethiopia. In order to achieve the stated objective a synthesis model of monetarist and cost-push inflation theories is estimated using vector autoregressive (VAR) and single equation error correction models. The estimated models enable to understand the short run and the long run inflation dynamics in Ethiopia between 1980 and 2017.The result shows that in the long run real money supply. Real GDP growth real effective exchange rate and Budget deficit have significantly affect inflation. But budget deficit and real GDP is not found the expected sign rather. The short run the change in real GDP growth and change real money supply significantly affect inflation. However the change real effective exchange rate and budget deficit are insignificant. The study suggests that adopting restrictive monetary and fiscal policy. Have essential tools to curb inflationary problem of Ethiopia.

Keywords: inflation, ECM,GDP,VAR

DOI: 10.7176/JESD/11-11-01

Publication date:June 30th 2020