The Determinants of Inflation in Ethiopia: A Multivariate Time Series Analysis

Inflation is a continuous increase in the general price level in an economy and falling of purchasing power of the monetary unit. In Ethiopia inflation was not generally an issue before the year 2003/04. Different studies point out their own reasons for the dynamics of inflation of the state. Generally, the aim of this paper to identifying the major sources of inflation. The study observed CPI and its components annually from 1970 to 2011. To identify the major sources of inflation in Ethiopia, the study presented, a VAR, co-integration analysis and the VECM allied with the descriptive analysis. The result of the VECM showed, only budget deficit as percentage of GDP is positively determining inflation of Ethiopia in the short run. In the short run the Broad Money Supply, Real GDP, the imported inflation of international petroleum price and the nominal exchange rate has insignificant effect of the annual Ethiopia’s price hike. In the long run, the Ethiopia’s inflation mainly driven by the Broad Money supply , the Real GDP, interest rate, the Nominal Exchange Rate, and the budget deficit with high significance level. The Broad Money Supply in the economy and the Banks and Financial institutions average lending rate has a positive long run effect on inflation. While, the Rainfall, the deficit budget and the Nominal Exchange rate has a negative long run determination of the price level in Ethiopia. Therefore, the government should follow planned government expenditure and by allowing the Banks and financial institutions lending rate determination should hold on the hand of the market rather than the government to curb inflation in Ethiopia. Keywords: VECM , Inflation, Ethiopia DOI: 10.7176/JESD/11-21-06 Publication date: November 30 th 2020