Modeling Inflation Volatility and its Effect on Economic Growth in Ethiopia
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Date
2012-06
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A.A.U
Abstract
Inflation volatility is a serious problem in the conduct of monetary policy. This is because
it makes economic planning difficult, affects investment decision and hence growth. This
study is aimed at modeling inflation volatility and analyzes its effect on economic growth
in Ethiopia. The study uses quarterly data on Consumer Price Index (CPI) and Gross
Domestic Product (GOP) for the period 1991 /92 -2010/ 11 . To model inflation volatility as
time varying process an extended form of GARCH (Generalized Autoregressive
Conditional Heterosedasticity) model i.e. Threshold GARCH is used. The study finds
strong evidence for the existence of Freidman-Ball hypothesis. TGARCH model is used
to allow for asymmetric effect of positive and negative inflationary shocks and the result
indicates strong asymmetric effect of inflationary shocks on inflation uncertainty.
Co integrated VAR model and granger causality test are also used to see the relationship
between inflation, inflation uncertainty and growth. From the cointegrated VAR model
the growth rate of GOP affects inflation positively in the long run and negatively in the
short run. The granger causality result indicates that inflation granger causes inflation
uncertainty positively and inflation uncertainty granger causes output growth negatively.
To prevent the negative consequences of inflation including uncertainty problem National
Bank of Ethiopia (NBE) should restore public confidence via credible policy instruments.
Furthennore detennining the threshold level of inflation-gro:vth relationship is important
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to know the type of relationship that exists between growtl'i and ~n.
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Keywords
Modeling Inflation Volatility, Economic Growth