Inflation in Ethiopia: Determinants and Its Effect on Human Development Index

Abstract

Ethiopian economy is unstable and inflation plays a lion’s share for such instability. As per its main objective, the study examined factors affecting inflation, and its effect on human development index (HDI) in Ethiopia for the period 1991-2021 using ARDL Approach. The data were obtained from national bank of Ethiopia. The study identified the direction of dynamic causality between broad money supply growth and growth in inflation using TYDL approach. The Philips Pearon unit root test employed showed that the series contain a mixture of I(0) and I(1) variables and that no variables is found I(2) implying that ARDL model is quite appropriate. And the coefficients diagnostics test results revealed that no evidence of serial correlation, no functional form problem and the residual is normally distributed with constant variance. Moreover, the Ramsey Reset test of parameter stability tests showed that the estimated ARDL modes are stable and therefore the parameters are unchanged over the three decades covered by the sample. The bound test (F-statistic) for ARDL in inflation found a long run relationship (co-integration) among inflation growth and its explainers. Besides, the error correction coefficient Inflation ARDL is estimated significantly at negative -0.351611. The bound test for the second model founds that inflation does not impact the human development of Ethiopia in the long run. Moreover, the first empirical model revealed that the growth in world gold price and the growth Ethiopian broad money growth increase the growth of inflation in Ethiopia in the long run. And in the short run, it founds that inflation in Ethiopia is positively determined by growth in government expenditure, in real interest rate and in one period lagged value broad money supply implying that historical money supply policies also matter. Moreover, it can conclude that money supply in Ethiopia has been inflationary both in the short run and in the long run. The findings of TYDL Granger Causality suggested that there exist bi-directional causality running from money supply growth to inflation and from inflation growth to money supply growth. And hence it can be concluded that money supply in Ethiopia is always an inflationary. Therefore, the policy implications drawn give an homework for national bank of Ethiopia and the Ethiopian government so that one may fight against high inflation by following appropriate set of economic policies and strategies.