The Effect of Monetary Policy on Economic Growth in Ethiopia

Abstract

There is an ambiguous relationship between monetary policy and economic growth both in theoretically and empirically. Hence, this study was examined the link among monetary policy and economic growth in Ethiopia by using time series data from 1980-2019. Zivot and Andrews (ZA hereafter) and Clemente (CMR hereafter) unit root test revealed that real interest rate was stationary at level. while log of real gross domestic product, log of gross capital formation, log of money supply, exchange rate, reserve requirement and consumer price index were stationary after first differencing in both tests. The results of ARDL bounds test for co-integration showed the present of long run relationship among the series during the study period. Long run estimation indicated that the existence of positive statistical significant effect of money supply, real interest rate, reserve requirement and gross capital formation on economic growth in Ethiopia during the study period. While, exchange rate has negative effect on economic growth. The study also revealed that, inflation has no significant effect on economic growth in the long run. The short run estimation showed that except inflation index, other variables (money supply, gross capital formation, reserve requirement and real interest rate) has positive significant effect on economic growth in Ethiopia in the study period. However, exchange rate has no significant effect in the short run. The Error correction model (ECM) test showed that about 29% of short run disequilibrium was be adjusted every year. The test of causality showed that a causation between real gross domestic product with inflation, exchange rate and money supply at 5% level of significant and a causality with gross capital formation at 10% level of significant. In conclusion, there were positive relationship most of the monetary policy instrument variables with economic growth except inflation and exchange rate for this study. As a recommendation, national banks of Ethiopia should be committed to the mission of price stability.