The Behaviour and Determinants of Real Effective Exchange Rate in Ethiopia
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Date
2009-11
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A.A.U
Abstract
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.
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Keywords
Exchange Rate, Real Effective