The Sources of the Recent Inflationary Experience in Ethiopia.
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Date
2008-06
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A.A.U
Abstract
One of the prime objectives of governments is achieving stable macroeconomic
condition. This objective requires that prices be kept to a reasonably stable level.
High and persistent inflation introduces uncertainties into the economy and may
lead to slowdown of economic growth by discouraging domestic as well as foreign
investments. It may also cause balance of payments problems by eroding a
country's competitive advantage. Moreover, because it hits the poor the most it
needs to be tackled.
This study aims at understanding the forces behind the current inflationary process
in Ethiopia. In order to achieve the stated objective a synthesis model of monetarist
and cost-push inflation theories is estimated using vector autoregressive (VAR) and
single equation error correction models. The estimated models enable to understand the short run and the long run price dynamics in Ethiopia between
1994/95 and 2007/08.
The findings of the study suggest that the determinants of inflation differ between
sectors (food and non-food) and the time horizons under consideration. The most
important forces behind food inflation in the long run are real income, money
supply, inflation expectation and international food price. The long run
determinants of non-food inflation, on the other hand, are money supply, interest
rate and inflation expectations. In the short run model, wages, international prices,
exchange rates and food supply are found to be prime sources of inflation. There is
also evidence of cost mark-up in the short run suggesting the presence of strong
monopoly power in price formation.
To contain inflation, therefore, the government needs to exercise prudent fiscal and
monetary policies. Inflation expectations need to be tackled by way of credible
government policies to change public opinion_ In this regard it is important to
consider targeting of macroeconomic variables and adhere to announced targets.
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Keywords
Experience in Ethiopia, Sources of the Recent Inflationary