An Empirical Investigation on Monetary Policy Transmission Mechanism in Ethiopia
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Date
2013-06
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Addis Ababa University
Abstract
This study investigates empirically the monetary transmission mechanism in Ethiopia to better inform monetary policy, which is currently dedicated to price and exchange rate stability. The study analyses long-run equilibrium relationships, adjustment mechanisms and short-run influences between the output, price level and transmission channels: namely, the exchange rate; the interest rate; money supply; and credit channel. In order to analyze the transmission mechanisms of monetary policy, the study uses vector autoregression and vector error correction mechanism (VECM). In addition, impulse response functions (IRF) and variance decompositions (VDC) techniques are employed to assess the relative strength of each channel. The results of econometric analysis suggest that monetary policy in Ethiopia had a relatively significant influence on the real activity through the direct monetary transmission and exchange rate channel. Besides, the results of statistical tests suggest that the interest rate channel is not active. Although the cointegration analysis showed that domestic credit have significant impact in the long run, both the VDC and IRFs implies weak existence of the credit channel. In order to strengthen the monetary transmission mechanisms that exist in the country a continued effort need to be made to develop the domestic financial sector and to adjust exchange rate to maintain external competitiveness. .
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Monetary Policy Transmission Mechanism in Ethiopia