Abstract
The paper tries to develop a model for the real exchange rate misalignment of Ethiopia. More specifically, the study attempts to examine whether Ethiopia\'s real exchange rate is misaligned with respect to its long run equilibrium level and answers such question as: (1) what are the constituent parts of the long run equilibrium RER? (2) Which variables set the movement of the equilibrium real exchange rate? (3) Based on the findings calculate the degree of misalignment and (4) what policy measures could be taken to realign the real exchange rate with its equilibrium level. The empirical estimation results conclude that, terms of trade (TOT), external aid inflows (ODA), commercial policy stance (CPS) and investment to GDP ratio were found to influence the long-run real exchange rate in the case of Ethiopia. However, variables such as nominal devaluation and real money supply found to have no effect on the real exchange rate. Ethiopian Journal of Economics Vol. 15 (2) 2006: pp. 29-50
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