The Behaviour and Determinants of Real Effective Exchange Rate in Ethiopia

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This paper adopts co-integration and vector error correction approaches to examine the behavior, and the short run and long run determinants of the quarterly real effective exchange rate; and measure the resulting misalignment in Ethiopia during the period 1993: I to 2008:2. The data evidence shows that both the actual and equilibrium real effective exchange rates in Ethiopia have been depreciating from 1993: 1 to 2004:4. After 2004:4, while the actual value started to show significant appreciation, the equilibrium value has followed a fairly constant trend. The econometrics result reveal that government consumption spending and growth in net domestic credit depreciates the real effective exchange rate both in the short run and the long run; while the ratio of fiscal deficit to high powered money and real international price of oil both lead to currency depreciation in the short run. The real international price of oil is found to have an opposite impact in the long run. On the other hand, the degree of foreign exchange and capital controls lead to currency appreciation in the long run. Furthermore, the estimated long run equilibrium real effective exchange rate and the degree of misalignment show that in general, long run equilibrium exchange rate in Ethiopia doesn't seem to be constant and misalignment ranged from 30.7 percent to -34.3 percent. The recent increase in the actual real effective exchange rate relative to its long run equilibrium value calls for a closer attention on the side of policy makers to combat a fall in the international competitiveness and possible currency crises.



Exchange Rate, Real Effective