Macroeconomic Determinants of Inflation in Ethiopia: ARDL Approach to Cointegration

Abstract

Maintaining inflation rate at optimal level is among important mechanism of balancing macroeconomic volatility to ensure steady economic growth. This study aims to examine macroeconomic determinants of inflation in Ethiopia. The study employed ARDL model using annual data for period 1981–2020. The ARDL bound test was applied to examine the presence of con-integration between inflation and independent variables. The study also uses augmented Dickey-Fuller and Phillips-Perron unit root tests to check stationarity of the variables. The test result reveals that almost all variables become stationary after the first difference. Accordingly, the result from bound test indicated existence of long run relationship between the dependent variable and explanatory variables entered into the model. The estimated error correction model (ECM) with −0.53 coefficient also confirms the existence of co-integration with high speed of adjustment towards the long run equilibrium. In the long run: real GDP, real effective exchange rate, lending interest rate are positive and significant determinants of inflation whereas broad money supply, real GDP, population growth, gross national saving and previous year imports are found to be the short run drivers of inflation. The finding recommends, among others, measures on reducing real effective exchange rate and utilizing broad money supply in productive economic activities along with supply side should be designed to contain inflation in Ethiopia.

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