Monetary Policy and the Monetary Approach to the Balance of Payments: The Case of Ethiopia (1967/68 - 1999/00)
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Date
2001-06
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A.A.U
Abstract
This paper empiricallv tests the reserve flow equation of the monetary approach to the
balance of payments in the case of Ethiopia during the period J967/68 to J999/00 with
quarterly dies-aggregated data. It examines whether disequilibrium in the money market
played a role in determining balance of payments deficits. The study employed the Johansen
Maximum likelihood vector error correction modeling technique. Reserve or balance of
payments is assumed to depend on domestic credit, domestic price, real income, interest rate,
money multiplier and exchange rate variables. Both the vector autoregressive and the vector
error correction mechanisms are estimated to determ.ine the long run and short run
relationships of the variables. The empirical result suggests that money played a significant
role in explaining balance of payments. The key proposition of the model, which is a one-to -
one offsetting relationship between reserves and domestic credit is not observed. Instead the
result suggests that a one percent increase in credit implies a 1.3 percent decline in reserves.
The policy implications is that given the assumptibns of the model, balance of payments deficit
can be improved through appropriate monetary and fiscal policies together with
complementary and reinforcing polices that remove supply side rigidities in the Ethiopian economy.
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Keywords
Balance of Payments, Policy and the monetary