The Effect of Domestic Currency Devaluation on Trade Balance in Ethiopia

Abstract

The prime objective of the study was to investigate the effect of domestic currency devaluation on trade balance in Ethiopian over the period 1974-2016. To address the objective, ARDL and Error Correction Model were applied. The ARDL bound test result shown that  There is  a long run relationship between real effective exchange rate, real domestic income and lending interest rate .Specifically, real effective exchange rate, real domestic income and lending interest rate have a significant and positive effect on trade balance; whereas money supply and government expenditure deteriorated trade balance while  deposit interest rate was insignificant in the long run. This clearly shows that both elasticity and absorption approaches improved the trade balance but monetary measures have deteriorated it. Hence; the government should take follow contractionary monetary policy and absorption approach through productivity improvement, diversification of export sectors and expansion of import computing industries to overcome trade deficit.

Keywords: Ethiopia, Trade Balance, Currency Devaluation, ARDL Bound test.

DOI: 10.7176/RJFA/11-1-03

Publication date: January 31^st 2020