“Assessing Effectiveness Of Monetary Policy In Controlling Inflation In Ethiopia.’’

Abstract

This study examined Assessing the effectiveness of monetary policy in controlling inflation in Ethiopia from 1991 to 2023, using an Autoregressive Distributed Lag (ARDL) model. Despite the National Bank of Ethiopia's (NBE) efforts to stabilize prices, inflation remains volatile, averaging 16% over the past decade, with peaks exceeding 30% due to external shocks, domestic supply bottlenecks, and rapid money supply growth. The study addresses gaps in existing literature by incorporating structural variables like external debt and unemployment, which mediate monetary policy effectiveness. The primary objective of the study was to assess the effectiveness of monetary policy in controlling inflation in Ethiopia using time- series data. Secondary data were sourced from the National Bank of Ethiopia, International Monetary Fund, and World Bank. The findings reveal that in the long run, broad money supply has a significant positive effect on inflation. Conversely; the reserve requirement ratio exhibits a negative and significant impact. External debt also shows an unexpected negative relationship with inflation. However, exchange rates, interest rates, and unemployment do not significantly influence inflation in the long run. Short-run analysis indicates a rapid adjustment mechanism, with deviations from equilibrium corrected at approximately 169% annually. Exchange rate depreciation temporarily reduces inflation, while other monetary policy instruments show limited short-term effects. Granger causality tests confirm that money supply, exchange rates, and interest rates influence inflation, with bidirectional causality between inflation and interest rates as well as external debt. The study concludes that while monetary policy plays a crucial role in inflation management, its effectiveness is constrained by structural and external factors. Recommendations include adopting disciplined monetary targeting, proactive RRR adjustments, enhanced exchange rate flexibility, and improved fiscal-monetary coordination. Future research should explore nonlinear effects, higher frequency data, and comparative studies with other emerging economies to refine policy frameworks.