Monetary Policy Transnission Mechanism in Ethiopia: Structural Var Analysis
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Date
2022-07
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Addis Ababa University
Abstract
Monetary Policy is increasingly important to maintain price and exchange rate stability and support sustainable economic growth. The main objective of this paper was to study and identify the main transmission mechanism of monetary policy in Ethiopia. To achieve the objective, secondary source of data was collected using quarterly time series data from 2000/01Q1 to 2020/21Q4. Small open economy structural Vector Auto Regression (SVAR) model with two vectors of variables. All the variables are tested for unit roots using Augmented Dickey Fuller and the Phillips–Perron test and model stability and other necessary tests was conducted. The results of Structural impulse response and structural variance decompositions derived from Structural VAR show that direct monetary transmission which is the Reserve Money in case of output and reserve money, domestic credit and nominal effective exchange rate have significant impacts on price level in short term. The monetary aggregate (M2), the average lending rate, the reserve requirement and nominal effective exchange rate have significant impacts on output and price level in medium term in Ethiopia indicating that monetary policy transmission channel is effective in influencing macroeconomic variables in the Ethiopian economy. However, the results of interest rate channel-which is represented by the average lending rate in affecting output and price is not effective in short run relative to other channels. while the study also illustrates that the monetary aggregate contains important additional information in the transmission process of monetary policy shocks in Ethiopia.
Key Words: Impulse, Monetary, Policy, Response, Decompositions, Ethiopia