An Empirical Investigation on the Monetary Policy Transmission Mechanism in Ethiopia

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.