ANALYSIS OF THE RELATIVE IMPACT OF MONETARY AND FISCAL POLICIES ON ECONOMIC GROWTH IN ETHIOPIA, USING ARDL APPROACH TO CO-INTEGRATION: WHICH POLICY IS MORE POTENT?

Abstract

Empirical investigation on the comparative potency of monetary and fiscal policies is still dubious among two major schools of thought in economics so called classical and Keynesian. Hence, this paper investigates the relative effectiveness of monetary and fiscal policies in affecting economic growth by employing Auto-Regressive Distributive Lag Model (ARDL) for the time spanning from 1975 to 2017. The proxies used in this study for monetary and fiscal policy were Broad money supply (M2) and government consumption expenditure respectively while real GDP at constant prices in 2010 is used as proxy for economic growth in Ethiopia. Anderson and Jordan (1968) “St. Louis equation’’ has been used to estimate the comparative potency of monetary and fiscal policies. The empirical results indicate that both the monetary and fiscal policies have equal statistically significant and positive impact on economic growth in Ethiopia with different significance level and magnitude. Besides of equal effectiveness, the elasticity of real output with respect to fiscal policy variable is greater than the elasticity with respect to money supply which show fiscal policy is more effective than monetary policy in influencing Real GDP in the long-run. However, in the short run, the fiscal policy is effective while that of the monetary policy proxy by money supply is ineffective in affecting output growth in Ethiopia. Therefore, to have continuous and sustainable economic growth, the coordination of monetary and fiscal policies are vital and the lack of this coordination leads to a sharp downturn of overall economic performance, even can hurt the economy.