Determinants of Real Exchange Rate in Ethiopia: An Empirical Investigation (198SQl - 2000Q2)
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Date
2001-06
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A.A.U
Abstract
This paper examines the role of real and nominal disturbance in explaining the movement of
real exchange rate in Ethiopia and assess whether the nominal effects are permanent or
transitory. The study also tried to see the extent of exchange rate misalignment.
In estimating the model, we first test for the time series properties of the model and indicate the
order of integration. The ADF tests, for unit root, showed that all variables except government
consumption, nominal devaluation and excess credit are integrated of order one. Johansen 's
likelihood ratio is employed for co-integration tests and these tests revealed that there is one
co-integrating vector.
The test for weak exogeneity also reveal that except real exchange rate and terms of trade all of
the variables are found to be weakly exogenous in the official exchange rate based REER
specification but all the variables except the dependant variable (weighted real exchange rate)
are weakly exogenous in the weighted exchange rate based REER specification. Findings in
this paper show that the main long run determinants of real exchange rate in Ethiopia are
terms of trade, government consumption, capital flow and import tariffs. However, the
estimated error correction model shows that nominal devaluation and domestic credit have
significant effect on the real exchange rate in addition to the above stated variables.
These findings indicate that trade and exchange rate liberalization have lead to depreciation in
the real exchange rate which in turn boosts exportable and improved the country’s BOPs
position. contractionary monetary policy also contributed significantly much in improving
exchange rate stability.
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Keywords
Exchange Rate in Ethiopia, Empirical Investigation