Macroeconomic Determinants of Inflation in Ethiopia

Abstract

Inflation has emerged as a critical economic challenge for Ethiopia, eroding consumer purchasing power. This study aims to identify the key determinants of inflation by examining its interactions with debt financing, government spending, GDP, exchange rates, and other relevant variables using time series data from 1982 to 2022. Employing econometric techniques like stationarity tests, cointegration analysis, error correction models, and Granger causality, the objectives are to determine significant short-run drivers of inflation and identify long-run influencing factors. In the short run, GDP growth, debt financing, government expenditure, exchange rates, and inflation expectations shape inflation dynamics. Unexpected events like natural disasters, conflicts, and policy changes also play a role. Long-term findings suggest GDP growth, debt financing, government expenditure, and exchange rates significantly impact inflation, though mechanisms differ from conventional economic relationships. The study emphasizes adopting coordinated fiscal and monetary policies, managing inflation expectations through transparent communication, addressing supply constraints, prudent debt management, aligning government spending with productive investments, and stabilizing exchange rates. A comprehensive approach tailored to Ethiopia's unique dynamics can help policymakers navigate inflation challenges and ensure price stability.