The relationship between inflation and economic growth in Ethiopia

Abstract

The main purpose of this study is to empirically assess the relationship between inflation \nand economic growth in Ethiopia using quarterly dataset from 1992Q1 to 2010Q4. In \ndoing so, an interesting policy issue arises. What is the threshold level of inflation for the \nEthiopian economy? Based on the Engle-Granger and Johansen co-integration tests it is \nfound out that there is a positive long-run relationship between inflation and economic \ngrowth. The error correction models show that in cases of short-run disequilibrium, the \ninflation model adjusts itself to its long-run path correcting roughly 40% of the \nimbalance in each quarter. In addition, based on the conditional least square technique, \nthe estimated threshold model suggests 10% as the optimal level of inflation that \nfacilitates growth. An inflation level higher or lower than the threshold level of inflation \naffects the economic growth negatively and hence fiscal and monetary policy \ncoordination is vital to keep inflation at the threshold.

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