Monetary Policy and the Monetary Approach to the Balance of Payments: The Case of Ethiopia (1967/68 - 1999/00)

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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.



Balance of Payments, Policy and the monetary