The Nexus between Inflation, Money Supply and Economic Growth in Ethiopia

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Date

2023-06-02

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A.A.U.

Abstract

This study explored the nexus between inflation, money supply and economic growth in Ethiopia using a quarterly time series data form 1997/98 Q1 to 2021/22 Q4. The study employed Structural Vector Auto regressive (SVAR) Model and descriptive statistics in order to analyze data collected from National Bank of Ethiopia (NBE) and World Bank economic outlook. The research shows that inflation in Ethiopia is caused by the money supply, supporting the monetarist theory and variations in the average inflation rate are extremely sensitive to changes in inflation expectations and substantially to changes in money supply increase. The percentage of currency in circulation and money growth had been steadily rising over time, which put further pressure on the overall price level. The research also shows that, in the short run, economic expansion has a negative impact on inflation. Economic growth lowers inflation if the primary drivers of such growth are noninflationary factors like a rise in output and productivity. But, monetary forces can only account for a portion of Ethiopia's inflation. Virtually, money supply increase caused by public credit expansion has a substantial and considerable impact on inflation since it keeps the country's currency's value from appreciating. Overall, the major policy implication of this study is that, the sensitivity of inflation to changes in monetary growth need to be taken into consideration by both monetary and fiscal policy makers and increased investments in agriculture and other food sectors are required as a result of price shocks related to the real production sector. Since, stronger inflationary expectations may have been the cause of the estimated larger than unit elasticity of the money supply, by guaranteeing credibility in the targeting and announcement of important economic and general policy variables, the influence of expectations on inflation can be also reduced.

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Keywords

Inflation, money supply, economic growth, Ethiopia

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