Abstract:
This study investigates empirically monetary transmission mechanism in Ethiopia. The study
analyses relationships, adjustment mechanisms and short run influences between the output and
transmission channels: namely, the exchange rate; the interest rate; money supply in monetary
base; credit channel and inflation in asset price. In order to analyze the transmission
mechanisms of monetary policy, the study used vector auto regression (VAR) and vector error
correction mechanism (VECM). In addition, impulse response functions (IRF) technique was
employed to assess the relative strength among each channel. The results of econometric
analysis suggest that monetary policy in Ethiopia had a relatively significant influence on the
real activity through the direct monetary transmission and exchange rate channel. Besides, the
results of statistical tests suggest that the interest rate channel is not active. Although the
cointegration analysis showed that domestic credit have significant impact in the long run,
impulse response function implies existence of the credit channel. In order to strengthen the
monetary transmission mechanisms that exist in the country a continued effort need to be made
to develop the domestic financial sector and to adjust exchange rate to maintain external
competitiveness.
