Effects of Monetary Policy on Inflation in Ethiopia: Using ARDL Co-Integration Approach

Abstract

Although many studies on linkage between monetary policy and inflation have been done in both developing and advanced countries, Notably Ethiopia has not featured in the cross-country studies that have included some of the Sub-Saharan African countries. Similar studies in Ethiopia haven not been conducted by including all necessary variables. Therefore, the study is to empirically investigate the effects of monetary policy on inflation in the case of Ethiopia. The study covers the annual data from 1988 to 2021 using time series ARDL co-integration regression analysis. The consumer price index is used as a proxy of inflation. The empirical results suggest that money supply, the openness of trade and the real effective exchange rate exerts a positive and statistically significant effect on inflation, in the long run, and real gross domestic product and real lending rate have a negative and statistically significant effect on inflation in the long run. The estimate of the speed of adjustment coefficient found in this study indicates that about 21.4 per cent of the variation in the inflation from its equilibrium level is corrected within a year. Based on the findings of the empirical analysis, the study recommends that Spends the money to the economy should not exceed the country's production of goods and services. Government should implement major changes to ensure that more of the money in circulation is in the productive sector.