Effect of Monetary Policy on the Economic Growth of Ethiopia: An Autoregressive Distributed Lag (ARDL) Approach

Abstract This study analyze the effect of monetary policy. To address this objective this study employed ARDL and error correction model (ECM) based on annual data from 1993 to 2022. Granger causality test was also employed to check the direction of causal effects of one variable on the other variable. All required pre and post estimation test were performed and verified that the model was statistical viable. The study revealed that, In short run, deposit interest rate, reserve required amount and open market operation have positive and statistically significant effects on real GDP growth of Ethiopia, however, money supply have negative and statistically significant effects on real GDP growth of Ethiopia. In long run, money supply have positive and statistically significant effects on real GDP growth of Ethiopia, however, deposit interest rate and reserve required have negative and statistically significant effects on real GDP growth of Ethiopia. To sum up, in short run contractionary monetary policy was promising and in long run expansionary monetary policy was favorable effect on economic growth. The Granger causality test result shows that there is bidirectional causality between monetary policy and economic growth; except there was unidirectional relationship between deposit interest rate and economic growth. Ultimately, this research suggests the following policy recommendation: for short-term economic enhancement, it is advisable for the government to opt for a contractionary monetary policy rather than an expansionary one. On the other hand, for long-term economic improvement, an expansionary monetary policy is more favorable than a contractionary one.