Macroeconomic Determinants of Inflation In Ethiopia

Abstract

Maintaining the inflation rate at the appropriate level is crucial for stabilizing macroeconomic fluctuations and ensuring steady economic growth. This study examined the macroeconomic factors influencing inflation in Ethiopia and assessed their significant impact. Using the ARDL model, annual data from 1983 to 2022 sourced from the National Bank of Ethiopia, cross national time series data, and World Bank databases were analyzed. Unit root tests such as augmented Dickey-Fuller and Phillips-Perron were conducted to evaluate variable stationarity, revealing that variables became stationary at intercept and first difference. The ARDL bound test was utilized to explore co-integration among the variables, indicating a long-term relationship within the model. The error correction model (ECM) with a coefficient of -0.15 further validated the presence of co-integration, showing a moderate adjustment towards long-term equilibrium. In the long run, broad money supply, real effective exchange rate, government crises, and real GDP were identified as significant factors influencing the consumer price index (CPI), while the real lending interest rate had a weaker impact on CPI. In the short run, real GDP, official exchange rate, real effective exchange rate, imports of goods and services, broad money supply, gross national saving, and real lending interest rate were found to drive inflation. Additionally, one-year lagged CPI, one-year lagged official exchange rate, one-year lagged real effective exchange rate (all in natural logarithm), and one year lagged government crises were significant influences on CPI in the short run. To address inflation in Ethiopia, the study recommends implementing policies to reduce the real effective exchange rate, utilizing broad money supply effectively in avoiding monetization for deficit financing by maintaining good diplomatic relations to borrow money from abroad and domestic lenders, engaging in political dialogue to tackle government crises leading to inflation, and implementing supply-side measures to stabilize the market.