The Demand for Money and Monetary Policy in Ethiopia
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Date
2005-06
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A.A.U
Abstract
It is repeatedly noted that the existence of a stable demand for money function IS very
crucial for the conduct of monetary policy. Accordingly this study attempted to estimate a
demand for money illation for Ethiopia using quarterly data ranging from 1970171 :1 to
2003104:lV. The study tried to estimate both the long-run and short-run demand for real
narrow money balances using the Johansen multivariate framework by taking real GDP,
the saving deposit rate, the inflation rate and the depreciation rate of the birr in the
paraUel market as explanatory variables. The depreciation rate of the birr in the parallel
market was, however, dropped from the long-run model as its inclusion could not result in
a meaningful co integration relationship. Thus, in the long-run demand for real narrow
money holdings was found to depend positively on real GDP and negatively on the saving
deposit rate and the one period-lagged inflation rate. The coefficient of real GDP was also
close to unity consistent with the quantity theory of money. Of the two opportunity cost
variables in the model the inflation rate was found out to have a much pronounced impact
on the demand for money reflecting the low level of development of the financial system.
In the short-run, only lagged values of money holdings and real GDP were found out to
have significant impact on the demand for money. None of the opportunity cost variables
were found to have any impact on the demand for money in the short-run. This is due to the
low level of development of the financial system which limits the availability of many
alternatives to money holdings. This observation is corroborated by the very low coefficient
of the error correction term in the vector error correction model which shows the speed of
adjustment to long-run equilibrium.
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Keywords
Monetary Policy