Impact of Broad Money supply and Domestic Credit to Private Sector On Economic Growth in Ethiopia

Abstract

The role of money supply along with domestic credit to the private sector is considered very critical in an economy. It helps to improve economic growth and economic development of a country Thus, in this study we aim to investigate the possible roles of Broad Money supply and Domestic Credit to Private Sector on Economic Growth in Ethiopia by using annual time series data ranging from 1981 to 2021. The autoregressive distributed lag (ARDL) approach to co-integration is adopted to check the presence of long-run equilibrium between the growth and two variables. In addition, to check the stationarity in the data, we employed both augmented Dickey-Fuller (ADF) and Philips-Perron (PP) tests, whereas the long- and short-run elasticities were estimated using the Vector Error Correction (VEC) procedure. In addition, we capture the direction of causality between Broad Money supply and Domestic Credit to private sector and economic growth by the Granger causality procedure to elucidate which one of the two hypotheses whether the two variables or Economic growth that holds in Ethiopia. Accordingly, the estimated short and long-run elasticities indicate that while broad money supply (M2) is identified as the key determinant of economic growth in the short-run, domestic credit to the private sector is found to be weak in affecting economic the short-run economic growth. On the other hand, M2 is found to be a growth deterrent in the long run, whereas domestic credit to the private sector positively contributes to economic growth. On the other hand, the direction of causality was unidirectionally running from M2 to economic growth, supporting the supply-leading growth hypothesis, while no significant causality was revealed between domestic credit and growth. Thus, from the above empirical findings we emphasize that though components of financial development could significantly affect economic growth in both short- and long-runs, thus, targeting the Broad money supply in a short run and Domestic credit to Private sector as a policy option could be significant in achieving economic growth in Ethiopia