The Economy Wide Impact of the Devaluation of Ethiopian Currency: A Recursive Dynamic Computable General Equilibrium Approach
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Date
2018-06
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Addis Ababa University
Abstract
In recent times, Ethiopia has experienced far-reaching economic growth and development changes. Despite this growth, the country has been chronically running a trade deficit. Devaluation is one of the most important but controversial trade policies recommended by the IMF for most of the developing countries in restoring the trade balance and increasing real GDP growth. To this end, this study analyzes the economy-wide impact of the devaluation of Ethiopian currency (birr) using Dynamic Computable General Equilibrium (DCGE) Model. The model used an updated version of 2009/10 Ethiopian SAM developed by Ethiopian Development Research Institute (EDRI). Three different simulation scenarios have been simultaneously used to evaluate the real impact of devaluation on the economy; 15%, 25% and 35% increase in exchange rate respectively. The findings of the study reveal that devaluation results in a decline in the overall GDP growth and domestic absorption. On the other hand, the trade balance has been improved under all simulation scenarios. Moreover, the productions of agriculture and service sectors expand whereas that of the industrial sector shrinks at a higher rate. By and large, real consumption, fixed investment, GDP, government revenue and household welfare are all adversely affected justifying that devaluation has contractionary effects on the Ethiopian economy. Based on the findings, the researcher suggests the monetary authority to stick to its managed floating policy stance and make changes in cautious and predictable manner. Moreover, there is an obvious need to combine monetary policy measures with fiscal policy in order to promote sustained economic development.
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Thesis Submitted to the Department of Economics Presented in Partial Fulfilment of the Requirements for the Award of the Degree of Master of Science in Economic Policy Analysis
Keywords
Devaluation, DCGE, Exchange rate, Export