The Effect Of Monetary Policy On Inflation In Ethiopia

Abstract

Inflation is one of the macroeconomic variables that practitioners usually focus on because it hurts the life of poor in particular and social welfare in general. It has been identified in the literatures that supply side bottlenecks, excessive aggregate demand and structural factors are the major source of inflation although the relative importance of each factor in explaining it varies from country to country. The objective of this study is to examine the effect of monetary policy variables on inflation proxed by consumer price index in Ethiopia. The result from Auto Regressive Distributive Lag indicates that expected inflation, real gross domestic product, money supply and real interest rate are the major determinants of inflation both in the long and the short run. Moreover, government expenditure, domestic credit and remittance inflow are also the main determinants of inflation in the short run. This study implies that government should design and follow policies that stabilize expectation of economic agents, ensure positive real interest rate, control money supply and promote domestic production. The movement of exchange rate, growth of money supply, government expenditure and remittance inflow should be in a way that it does not bring inflation. Furthermore, facilitating access to credit is also essential to promote real output and stabilize inflation. Finally, monetary authority that sets clear inflation target and committed to it is indispensible.