Making the Ethiopian Banking System Ready for Green Growth and Development

Abstract

ABSTRACT After two decades of high economic growth and fast development progress, Ethiopia is facing significant macroeconomic challenges such as high inflation, foreign exchange shortage, and slowing growth. At the same time, it is imperative to bring the economy on a green and climate-resilient development path. In this context, the financial sector has an essential role to play. International financial institutions recommend reducing the fiscal deficit to dampen money growth and inflation and giving up exchange rate control. Based on an alternative analysis of inflation, this article argues that money supply restrictions and fiscal austerity may not only prove ineffective in addressing inflation while incurring high economic costs, but also impede a response that comes via productive and green investment to ease the economy’s supply-side constraints and to lower inflation. Rather than fixating on the quantity of money and market exchange rates, central banking should focus on the direction of financial flows to make sure they go into real green investment rather than speculative and inflation-driving investment. This policy blueprint will also reduce balance-of-payments problems and improve both internal and external monetary stability.