A Macro-Econometric Approach Explaining the Causes and Dynamics of Price Inflation in Ethiopia

Since 2004, Ethiopian economy had been continually facing unprecedented and double digit inflation growth. Using annual data over the past three decades (1980 to 2012), the study identified short run and long run dynamic interactions among key macroeconomic indicators involving structural and or domestic, monetary and external factors. The empirical strategy combines two separate estimations: the VECM and a multi factor single-equation model. The study found that the effect of supply side, monetary and external factors are highly significant to explain price inflation through their long run co-integrating (equilibriums) relationships. In the short run, changes in inflation are highly sensitive to the change in money growth, the cost of capital, exchange rate and inertia. Policies that geared towards concurrently maximizing agricultural growth, and flourishing structural rigidities on the one hand and pursuing monetary tightening and stable exchange rate polices on the other hand would enable to ensure stable inflation. Keywords: Inertia, Agricultural Goods Market, Money Market, Exchange rate, Structural rigidities, and VECM