Effects of Monetary Policy on the Economic Growth of Ethiopia: An Autoregressive Distributed Lag (ARDL) Approach
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Date
2021-12
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A.A.U
Abstract
This study empirically investigated the effects of monetary policy on the economic growth of Ethiopia both in short run and long run. To achieve this objective the study used Auto Regressive Distribute Lagged (ARDL) model using annual time series data for the period of 1981 to 2019 to investigate the existence of short-run and long-run relationship between real GDP growth and set of monetary policy variables. In addition, the study used the variance decomposition (VDC) and impulse response functions (IRF) to test for the response of real GDP growth to innovations in monetary policy variables. Granger causality test was also employed to check the direction of causal effects of one variable on the other variable. The results of econometric analysis suggest that monetary policy in Ethiopia have a relatively significant influence on the real GDP growth through the direct money supply (M2) and real interest rate (RIR).In addition the co integration result showed that inflation rate has also negative significant impacts on the economic growth of Ethiopia both in the short run and long run. However, real effective exchange rate, gross fixed capital formation and budget deficit are found to have insignificant impacts on the economic growth of Ethiopia particularly in the long run according to the co integration result. However, in the short run real effective exchange rate, gross fixed capital formation and budget deficit are found to be influential impacts on the economic growth of the country. Although the co integration analysis showed the real interest rate have significant impact in the long run, the VDC shows the existence of weak relationship between real GDP and real interest rate in affecting economic growth of Ethiopia. The co integration analysis also showed gross fixed capital formation have insignificant impact in the long run, however, the VDC result implies the strong association between RGDP growth and GFCF particularly in the long run. And also there is one direction causal effect moving from GFCF to RGDPG of Ethiopia. More importantly despite the co integration results displays the insignificance long run impacts of real effective exchange rate, the result of IRF reveals the existence of negative significant long run relationship between the two monetary policy variables. Hence, in order to strengthen monetary policy that are operating in the country monetary authority should focus on the direct money supply and also a continued effort need to be made to develop the domestic financial sector, Open market operation, reduce fiscal dominance, control inflation rate and to adjust exchange rate to maintain external competitiveness.
Keywords: Monetary Policy, Real Gross Domestic Product, Broad Money Supply , Real Interest Rate and ARDL model.
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Keywords
Broad Money Supply, Real Gross Domestic Product