Abstract:
One of the most closely watched variables in order to design effective monetary policy is income
velocity. Income velocity relates monetary aggregates to economic activity. In line with this, the
present study has examined the determinants of income velocity of both narrow and broad money
definition in Ethiopia between the period 1970/71 up to 2010/11 using multivariate co-integration
analysis.
To achieve the objective of the study: unit root test, co-integration test and stability test are carried
out. The result of unit root test shows that the series are stationary at first difference. The study
suggest the existence of a unique and statistically significant relationship between the variables
under consideration and income velocity of both money definitions. The stability test shows that
the relationship is stable for both definitions of income velocity.
The result of Johansen co-integration test indicates economic growth and inflation has significant
positive effect on income velocity of both money definition. The result implies that money issuing
authorities cannot obtain additional power by issuing more money without generating high
pressure on inflation. The result also shown that proxy offinancial development has negative effect
on both models which supports the hypothesis that the country economy might be operating at
earlier stage offinancial development. Finally, real effective exchange rate found to have positive
effect on velocity of broad money definition. So, it is better to take in to account the stage of
financial development and level of exchange rate in forecasting income velocity in Ethiopia.
