Exchange Rate Pass-through in Ethiopia

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Addis Ababa University


The recent sharp devaluation by the central bank aggravates the inflation rate from single inflation rate of 5.3% in August 2010 to 10.6% in October 2010 following only a month after the devaluation occurred and 40.1% in September 2011 after a year. Initiated from this fact, this paper investigates the exchange rate pass-through to inflation and other macroeconomic variables in Ethiopia for monthly data ranging from July 2002(the beginning of Ethiopian fiscal year 2002/03) to June 2011(the end of Ethiopian fiscal year 2010/11). The study apply Six-Variable unrestricted VAR model to estimate the impulse response functions (IRFs) and variance decompositions (VDCs). In order to measure the pass-through coefficient to CPI, the study applies standardization of the exchange rate shock which helps to transform the shock from one standard Deviation to one percent. Hence the result shows that, on average a percentage change in exchange rate will increase the consumer price by 4.75% percent in the first year. The exchange rate pass-through to inflation almost dies out after two years of the exchange rate shock. The result also support Taylor‘s hypothesis which states that: high inflation leads to high level of exchange rate pass-through. Hence, the study concludes that, exchange rate change has prominent effect on Ethiopian inflation environment.



Rate Pass-Through