Abstract:
The Ethiopian Economy has the feature of low and stable inflation before the period
2002/03. However, in the post 2002/03 period continues rise in the prices level along
with sustained and rapid economic growth has been emerged. On the basis of this
situation, this study has examined the existing causal relationship between inflation and
money supply and between inflation and economic growth in Ethiopia for the period
1970/71-2010/11. The study used tri-variate Granger causality with VECM methodology
along with impulse response function analysis. Statinarity tests, selection of optimal lag
length and cointegration tests are under taken before estimation of the model. The test of
stationarity revealed that CPI, money supply and RGDP are non-stationary in level and
they become stationary at first difference. The Johansen cointegration test indicates the
presence of one cointegrating vector and the VECM demonstrates the existence of long
run bi-directional causality between inflation and money supply and uni-directional
causality from economic growth to inflation. In the short run one way causality were
found from money supply and economic growth to inflation. Furthermore, the impulse
response function shows the response of inflation in money supply and economic growth
shocks. Therefore, the key findings of the study are inflation is a monetary phenomenon
in Ethiopia and inflation is negatively and significantly affected by economic growth.
Thus, based on the results of the study, monetary policy should be planned to maintain
price stability by controlling the growth of money supply and combined effort should be
made by policy maker to increase the level of output by improving productivity and
supply so as to reduce the prices of goods and services (inflation) and boost the growth of
the economy.
