Determinants of inflationary experience in Ethiopia

Abstract

The main aim of this study is to investigate the determinants of inflationary experience in Ethiopia. The study focused on economic and econometric criterion to examine the long run and short run impacts of macroeconomic variables on inflation in Ethiopia. In order to accomplish this paper, the study has employed time series data for the period from 1974/75 to 2014/15. To check for the stationarity of the variables, the researcher has used augmented dickey fuller and Phillips-perron unit root test and all variables become stationary at first difference. Then, long run and short run estimates had been examined by using Johansen Co-integration methodology and Vector Error Correction approach with lag length of two. Data on macroeconomic variables were taken from National Bank of Ethiopia, Ethiopian Economic Association and World Bank database. The most visible determinants of inflation in Ethiopia are money supply, real gross domestic product and overall budget deficit. The findings of the study indicated that in the long run consumer price index has found to be positively influenced by money supply, real gross domestic product and overall budget deficit in which these all variables are positive and statistically significant determinants of inflation. Long run elasticity of price level with respect to broad money supply, real gross domestic product and overall budget deficit are 0.5922, 0.5299 and 0.3604 respectively. In the short run, only last year overall budget deficit is involved in affecting consumer price index of current year. The growth of money supply should be continually kept in control, given its long run potential impact in accelerating inflationary pressure in order to ensure stable price level in an economy and keep on the growth of real gross domestic product with single digit inflation rate, since single digit inflation is essential for economic growth. Also displaying a high sense of transparency in fiscal operations to bring about a realistic budget deficit that would serve as incentives to productivity; hence, the general price level will be stable