DEBRE MARKOS UNIVERSITY

COLLEG OF BUSINES AND ECONOMICS

DEPARTMENT OF ECONOMICS

THE IMPACT OF MONY SUPPLY ON ECONOMIC GROWTH

IN ETHIOPIA
A research submitted for department of economics in debre markos
university in partial fulfillment of the requirement for bachelor
degree in art economics program
PREPARED BY ID/NO
1. MELKAMU FENTAHUN…… ...…………………………..3704/07
2.DEMELASH TADESSE…….……………………..………..3656/07
3. MEKONEN BIRHAN……………………………………….3699/07
4. DESTAYE ALAMRAW………...…………………………..3009/06
5. DEGULODAMO…………...………………………………..3664/07

ADVISOR:-TILAHUN.D (Msc)
Submission date 21/09/09 E.C

Acknowledgment
First and for most, we would like to thanks Almighty God and his mother Saint Marry for
helping me to accomplish our will and with him nothing impossible. Secondly our special
appreciation and thanks also goes to our advisor Tilahun. D (Msc) for his encouragement,
insight, guidance and professional expertise in each phase of research. Without his role and
contribution it would have been hardly possible to complete this paper.

Our special thanks and appreciation goes for our family for their moral and financial assistance.
We would like to express our heartfelt thanks to group member for any assistance to ours for
completed this paper, GOD pays his favor. We wish to extend our gratitude and respect to
teacher Aynalem(Msc) for his assistance even if we don’t have enough word to explain about
his favor.

Finally, our appreciation goes to our intimacy for their moral support, especially, Bereket .T
Abstract
The study primarily aims at determining the relationship between money supply and
economic growth in Ethiopia over the period 197374/ to 2013/14 using Multiple Linear
Regression Model (OLS) with the aid of stata12 and Eview6 software package. Secondary
data collected from different sources including World Bank (WB), National Bank of Ethiopia
(NBE), Central Stastical Authority (CSA) and other sources was used. In the regression
model, in addition to the key variable (broad money supply) control variables including
inflation personal saving and population growth are included to enable ceteris paribus
interpretation of the relationship between money supply and economic growth. The estimated
result suggests that money supply has positive impact on economic growth. In addition to
money supply, personal saving and population growth have positive and significant impact
on real gross domestic product (real GDP) with in the period under study. The findings are
of direct relevance to the conduct of monetary policy by the national bank of Ethiopia. The
government should be promoting expansionary monetary policy. These means the
government either increase the amount of broad money supply or reducing interest rate. This
is because eventually economic theory suppress that an increase in money supply could leads
to inflationary pressure in another study.
 Table of content
Contents page
Acknowledgment--------------------------------------------------------------------------------
Abstract ------------------------------------------------------------------------------------------
Acronyms ----------------------------------------------------------------------------------------
CHAPTER ONE
1. Introduction ----------------------------------------------------------------------------------
1.1. Back ground of the study-----------------------------------------------------------------
1.2. Statement of the problem------------------------------------------------------------------
1.3. Objective of the study-----------------------------------------------------------------------
1.4. Scope of the study ---------------------------------------------------------------------------
1.5. Significance of the study --------------------------------------------------------------------
1.6. Limitation of the study ----------------------------------------------------------------------
1.7. Organization of the study --------------------------------------------------------------------
CHAPTER TWO:
2. Review literature-----------------------------------------------------------------------
2.1. Theoretical literature -----------------------------------------------------------------------------
2.1.1. The relationship between economic growth and money supply -------------------------
2.1.2. Definition of money supply ------------------------------------------------------------------
2.1.2. The structure and trends of economic growth (1974/75-2005/06) ----------------------
2.1.3. Why Money Supply Is Important? ---------------------------------------------------------
2.1.4. Monetary Policy and Macroeconomic Performance---------------------------------------
2.1.4.1. Framework of Ethiopian Monetary Policy------------------------------------------------
2.1.4.2. Monetary Policy Instruments---------------------------------------------------------------
2.1.4.3. Transmission Mechanism of Monetary Policy-------------------------------------------
2.1.5. Monetary Policy Objective -------------------------------------------------------------------
2.1.6. Monetary Policy Strategy/Targeting Framework -----------------------------------------
2.1.6.1. Final and Intermediate targets -------------------------------------------------------------
2.1.6.2. Operational target ----------------------------------------------------------------------------
2.1.7. What Factors Affects the Effectiveness of Monetary Policy In Ethiopia? -------------
2.1.8. What Are The Determinants Of Money Supply In Ethiopia? ----------------------------
2.2. Empirical literature ------------------------------------------------------------------------------
CHAPTER THREE
3. Research methodology -----------------------------------------------------------------------------
3.1. Source and type of data--------------------------------------------------------------------------
3.2. Model specification and estimation techniques----------------------------------------------
3.3. Method of data analysis ------------------------------------------------------------------------
3.4. Descriptions of variable ------------------------------------------------------------------------
3.5. Statement of hypothesis ------------------------------------------------------------------------

CHAPTER FOUR
4. Data analysis and presentation --------------------------------------------------------------
4.1. Descriptive analysis of Ethiopia economy -----------------------------------------------------
4.1.1 Trends in economic growth and money supply----------------------------------------
4.2. Econometrics analysis -----------------------------------------------------------------------------
CHAPTER FIVE
CONCLUSION AND RECOMMENDATION
5.1. Conclusion --------------------------------------------------------------------------------------------
5.2. Recommendation -------------------------------------------------------------------------------------
List of tables

Table 2.1: share of real GDP growth rate----------------------------------------------------------------

Table 4.1:descrpitive stastics of RGDP,Ps. M2,In and POP----------------------------------------------
Table 4.2: stationary test results---------------------------------------------------------------------------
Table 4.3: result Eview6 for estimation method--------------------------------------------------------
Table 4.4: summary of prior signs------------------------------------------------------------------------
Table 4.5: multicollinarity test----------------------------------------------------------------------------
Table 4.6: co integration test-----------------------------------------------------------------------------
List of figures
Figure 4.1:trend of RGDP--------------------------------------------------------------------
Figure 4.2: broad money supply and economic growth-------------------- ---------------------------
Figure 4.3: inflation rate and economic growth------------------------------------------------------
Figure 4.4: personal saving and economic growth -------------------------------------------------
Figure 4.5: population growth and economic growth-----------------------------------------------------
Reference ---------------------------------------------------------------------------------------------------
Appendix ----------------------------------------------------------------------------------------------------

Acronym

CSA- Central Stastical Authority

NBE- national bank of Ethiopia ( National Bank of Ethiopia )
M2- broad money supply
OLS –ordinary least square
MOFED –ministry of finance and economic development
IMF-international monetary fund
WB-world bank
Ps- personal saving
I – investment
Pc- personal consumption
In- inflation rate
N-population growth rate
POP-population growth
M1-narrow money supply
EPRDF- Ethiopian people Democracy Republic Front
RGDP- real gross domestic product

CAHPTER ONE
1. Introduction
1.1 Background of the study

The relationship between economic growth and money supply has been receiving increasing
attention than any other subject matter in the field of monetary economics (Nega,2010). Because
money supply plays a great role for economic growth, persistent concern has always been given
among monetary economists including Mackinnon and Shaw (1973), Fry Matheson (1980), et al
(1997) by explaining its relationship with in economic growth.

Economists have dissension on the effect of money supply on economic growth. While some
believe that the most important determinant of economic growth is variation in the quantity of
money and that countries that devote more time to studying the behavior of aggregate money
supply rarely experience much variation in their monetary economics literature that is called the
Quantity of money or gross national income (Robinson,1956).

Economists differ with regard to the effect of money supply on economic growth. Some argued
that variation in the quantity of money is the most important determinant of economic growth.
Kuznet (1955), support the view that financial markets start growing as the economic approaches
the intermediate stage of the growth process and develop once the economy became prospers.
A study of Gylfason (1987) reviewed the relationship between money supply and growth. The
evidence shows that credit expansion in several non oil developing countries was reduced
markedly and the overall balance of payments improved substantially.

According to Fisher (1932), as money supply changes, the price level and output changes
likewise the value of money (purchasing power).

Steve (1997) and Domingo (2001), explains that there may not be possibility of economic
growth without an appropriate level of money supply credit and appropriate financial conditions
in general. Reducing money stock through increased interest rates would lower gross national
product (GNP) . Thus the notion that stock of money varies with economic activities applies to
the Ethiopian economy (Laidler 1993).

As the Ethiopian economy characterized largely by underemployment the country produces less
than its potential national output (Alemayhu Gada 2008).Thus, money supply and economic
growth have seen different variation during the regimes.

During the dreg regime the growth rate of money supply had show that the broad money supply
on average increased by 23.5% from 1974 to 1981 E.C (CSA, 1981). During the regime
Ethiopian People Revolutionary Democracy Front (EPRDF), the growth rate of money supply on
average increased by 24.2% from (1992-2009) Thus, the growth rate of economy was improved
because the government adopted different monetary police, such as fiscal policy and monetary
policy purposely to improve the economic growth of the country.
Monetary policy is the process by which the monetary authority of a currency controls the
money supply often targeting an inflation rate or interest rate to ensure price stability and general
trust in the currency. Further goals of a monetary policy are usually to contribute to economic
growth and stability, to low unemployment, and to predictable exchange rate with other
currencies. It focuses on containing inflationary pressure and building international reserves of
the country. Efforts were made to make the growth of broad money supply in line with nominal
GDP growth. Accordingly, broad money to GDP ratio increased from 27.2 percent in 2009/10 to
29.1 percent in 2010/11 on account of remarkable growth in net foreign assets and domestic
credit. Similarly, annual reserve money growth was 39.7 percent owing to same reason. As for
interest rate, the NBE continued to set the minimum interest rate on saving and time deposits
while leaving lending rates to be freely determined by banks. The minimum interest rate on
deposits rate was set at 5 percent while lending rate ranged between 7.5 and 16.25 percent. As
inflation remained high, real rate of interest remained negative throughout the fiscal year.
(NBE,2010/11)
According to the IMF, Ethiopia was one of the fastest growing economies in the world,
registering over 10% economic growth from 2004 through 2009. It was the fastest-growing non-
oil-dependent African economy in the years 2007 and 2008. Growth has decelerated moderately
in 2012 to 7% and is projected to be 6.5% in the future – reflecting weaker external demand and
an increasingly constrained environment for private sector activity.
Ethiopia's growth performance and considerable development gains came under threat during
2008 and 2011 with the emergence of twin macroeconomic challenges of high inflation and a
difficult balance of payments situation. Inflation surged to 40% in August 2011 because of loose
monetary policy, large civil service wage increase in early 2011, and high food prices. For
2011/12, end-year inflation was projected to be about at about 22 percent and single digit
inflation is projected in 2012/13 with the implementation of tight monetary and fiscal policies.
Fiscal policy is largely based on the ideas of British economist Jon Maynard Keynes (1883-
1964) who believed governments could change economic performance by adjusting tax rate and
government spending. Monetary policy lay down by the central bank which is also a
macroeconomic policy. It involves management of money supply and interest rate and is the
demand side of economic policy used by the government of a country to achieve macroeconomic
objectives like, inflation, consumption, growth, liquidity and others (Mankiw,2000).

According to John Maynard Keynes (1936) when money supply increased by some amounts
simultaneously increased or expansion different investment activities in the economy It implies
that exist more money supply in the country be act the cause of the decreasing the interest rate of
money, increase less payment of interest rate the investors promoted for different investment
activities, this leads to economic growth of the country (ibid).

1.2 statement of the problem

This study is necessitated by the existence of certain problems. The major problems that trigged
of this work is the recurrence of general price instability ,persistent of inflationary pressures,
population growth and personal saving , in spite of the monetary policy measures adopted and
applied over the years. According to Milton Friedman (1956) and his followers, the government
should never take any kind of direct discretionary action to influence employment or spending
wages or prices. A limit of 4% to 5% on the rate of expansion of the money supply will take care
of the problem of inflation; automatic price adjustments and the automatic forces of the market
system will take care of unemployment and depression. The government should not do anything
to try to make the economy run better than it runs naturally. To the monetarists, there is just no
need to get involved with the Keynesian prescription. To do so would be harmful in the long run.
The government’s only economic policy should be to control the size of the money supply and
its rate of increase. As total output and trade increase, the money supply should be permitted to
increase enough to finance the increasing economic activity. But that is all.

The very basis, or ‘root cause’ of the disagreement between the monetarists and the Keynesians
stems from a basic difference in opinion about how to view the economy, and how the
macroeconomic forces in the economy actually operate. The monetarists take a long-run view,
and assume that the short-run ups and downs of the economy (inflation, unemployment, etc.) are
just short-run conditions which the natural market forces will work out in due time. The
monetarists assume that the economic forces of prices and competition will work more
effectively than would any government attempt to stabilize the economy. Because of the great
power and effectiveness of the ‘natural market forces,’ these factors should be allowed to control
the economy. The government should not try to offset or overthrow the results of these natural
forces. In short, the government should never try to achieve short-run price-level or production
and employment objectives (Friedman, 1959).

The Keynesian view of the economy is different. The Keynesians accept the proposition that the
natural market forces are powerful. But the Keynesians do not believe that these forces are
sufficiently powerful to guarantee healthy economy. The Keynesians focus on the fact that the
world only operates in the short-run.
Ethiopia has experiences seventeen years of economy stagnation under the leadership of Derg, a
military government. For example 1990/91 the growth rate of Ethiopia gross domestic product
(GDP) was -3.2 %, cyclical - unemployment was about 12 %, the rate of inflation was about 21%
. Along with this growth, however the country has seen an accelerated double digit increase the
price of goods and services. Thus inflation has remained as courage for Ethiopia economy
(Tadetal, 2008). The increased in national consumer price index or inflation has become very
determinate to the low and fixed income groups .Given the large portion of country's population
lives in absolute poverty (less than one of dollar per day ), it is time that the regime empower
identifies the slit factors that might be contributing to inflation in Ethiopia. Also its vital that
economic policy makers decisions strategies that could curtail the ongoing erosion of pure
purchasing power, to the curb inflation before it depends the economic crises and contributes to
political instability (Desta, 1993).

According to national bank of Ethiopia annual report during the year 2010/11 under review,
Ethiopia’s monetary policy was geared towards containing inflationary pressure. Accordingly the
National Bank of Ethiopia has been closely monitoring monetary development so as to arrest the
speed of inflation and inflation expectation. However, annual average head line inflation at the
end of the fiscal year reached 18.1 percent from 2.8 percent last year due the surge in
international commodity prices and marginal increase in base money.

At the end of 2010/11, domestic liquidity as measured by broad money supply (M2) reached Birr
145.4 billion reflecting 39.2 percent growth over last year, largely due to 104.2 percent surge in
net foreign assets and 29.8 percent growth in domestic credit. Domestic credit to the non
-government sector rose by 49.9 percent while credit to central government slowed down by 13.3
percent.

In terms of components of broad money, narrow money rose by45.3 percent due to 34.5 percent
rise in currency outside banks and 54.4 percent surge in demand deposits reflecting the growth in
economic activities and improvements in transactions demand for money. Similarly, quasi-
money that comprises savings and time deposits went up by 33.1 percent and reached Birr 62.9
billion, owing to improved financial intermediation by banks through opening up of 289 new
branches (NBE, 2010/11).

The inflationary economic growth process generates distortion in the allocation of resources
under the free market system. According to (Friedman, 1959) in every case where the inflation
rate of a country is high for any sustained period of time, its rate of money supply growth also
high.There is also this problem of general feeling that continuous annual rate of money increased
would adversely increase the rate of price level which would directly leads to inflation, which
many deny the intended effects of monetary policy measure to influence economic growth this
requiring a policy response. From the above issue, this research works will address the following
economic questions:-\
 How money supply affects economic growth in Ethiopia?
 How would monetary policy be used such that its intended effect of promoting
economic growth could be achieved?
 What is the impact of money supply on economic growth in Ethiopia?

According to Solomon et al, 2010 on this issue have reported positive relationship between in
money supply and economic growth the methodological technique the variable regress is money
supply, exchange rate and population growth rate period include only. As cited in (Sisay, 2008)
well reported is negative relationship between money supply and economic growth. So, no clear
consunces among scholars about the issue so, we will try to check whether there is positive or
negative relationship between money supply and economic growth in Ethiopia. Not only this but
also their methodological difference in studies. To the best of our knowledge not include in the
past studies for example personal saving, population growth rate and inflation rate.

1.3 Objectives of the study

1.3.1 General objective

The main objectives of the study would be examining the impact of money supply on economic
growth in Ethiopia.
1.3.2 Specific objective

 Examining the impact of money supply on economic growth in Ethiopia.

 Recommending policy options how money supply could be used more efficiently to
promote economic growth in Ethiopia.
 To assess how money supply affect economic growth in Ethiopia.

1.4. Scope of the study

The study would focused on the impact of money supply on economic growth in Ethiopia by
using the determinate variable of personal saving ,inflation rate, broad money supply and
population growth with regard to real growth of the economy .And lack of available data and
time the study would confined the period between (1974-2014 E.C)
1.5. Significance of the study

The study would try to see the money supply and other economic determinants understanding of
the relationship between money supply and economic growth. Therefore, this study would be
important to some researchers understand the relationship between broad money supply
,population growth , inflation rate, economic growth and personal saving other variables which
affect the economic growth of a country and use for further research.

1.6. Limitation of the study

The core limitation of the study were lack of reference material, enough data and access to
computer for STATA 12 software regression ,Eviews6 and in the editing time due to lack of
enough data the research covers the year of 1974-2014 and the like.
1.7 Organization of the study
The paper is organized into five chapters; the first chapter included the introduction, statement of
the problem, objective of the study, significance of the study and scope of the study. The second
chapter would contain review literature which includes theoretical and empirical literature; the
third chapter would incorporated methodology of the study, the fourth chapter includes
descriptive and econometrics data analysis and the final chapter is concerned with major
conclusion and recommendation based on the analysis of the findings.

CHAPTER TWO
2. LITRATURE REVIEW
The literature review includes both the theoretical and empirical literature. The theoretical
literature is assessing about the theoretical relationship between money supply and economic
growth monetary policy of Ethiopia and its objectives are also included under this part of the
literature. The empirical part of the literature review is focused on assessing about the
relationship between money supply and economic growth from previous studies on similar and
related studies.
2.1 Theoretical literature
2.1.1 The relationship between economic growth and money supply
Money is useful for forecasting economic activity only if there is systematic and stable
relationship between supply and economic activity. Most macro economic theories agree that
money is related to economic activity. In these theories, the relationship between money and
economic activity depends on whether money stock are due to shifts in money supply or money
demand. For example, increase in money supply spur economic activity or growth, while
increase money demand tends to be decreases the economic activity. And, these shift in money
supply demand affects output indirectly, through their effects on interest rate. Money are shift in
money supply are positively associated with output through their effect on interest rate. Money
supply increases for example, drives down interest rate to persuade investors to hold the
additional money balances. The decline in interest rates, intern, boosts interest sensitive
components of spending, such as, investment. Thus, increase in money supply reduce interest
rates and increase output (Mishkin, 2004).
A monetary economist argued that a general reduction in interest rate would increase the
availability of consumer goods as well as investment credit. An economist differs on the effect of
money supply on economic growth (Keynes, 1936)
According to Fishery (1932) as money supply cause the price level and output changes likewise
the value of money or purchasing power.
Nwankwonezeikchukw (2008) examines that there may not be possibility of economic growth
without an appropriate level of money supply credit and appropriate financial conditions in
general. Reducing money stock through increased interest rate would lower gross national
product (GNP). Thus the notion that stock of money varies with economic activities applies to
the Ethiopian economy.
Kuznets (1955) supports the view that financial markets starts grow as the economy approaches
the intermediate stage of growth process and develops once the economy becomes matured. This
entails that economic growth stimulates interested financial development.
2.1.2 Definition of money supply
The first known attempt to define the concept of money supply in Ethiopia economy was done
by monetarists agreed that the definition of money supply should base on the stage of
development of the financial system and the concept of money adopted which serves as a
working rule for measurement purposes and guided by the institutional framework of this
economy. Money supply can also be defined as the sum of all the money holdings of all the
members of the society. This could be either M or M2 in Ethiopia, M1, M2 and M3 in United
Kingdom (UK) or M1, M2, M3 and M4 in United States of America (USA).The M1 is a
narrow measure of money supply, it focuses on the role of money as a medium of
exchange and defines money as “currencies in circulation outs ide the banks plus demand
deposits held in banks” = C+DD. The central bank of Ethiopia defines M1 as currencies
outside banks plus positively held demand deposits. m 2 is a broad measure of money
supply. It includes savings and time deposits =C + DD for M1+SD+TD for M2 (NBE,2013).
The argument for including time and savings deposits of commercial banks is that they can
be converted into cash in short notice and used to carry out financial transactions. M+
comprises of M1 and M2 plus deposits held in other financial institutions including finance
houses, merchant banks and similar institutions (i.e. C+DD for M1 +SD+TD for M1+ Dᵪ for
M3). The arguments supporting M3 is the same as for M2 (i.e. it can be converted into cash
within a short notice). M4 comprises of M1, M2, M3 plus investment in government security in
government bonds and securities such as treasury bills and certificates, call money e.t.c.
Although money has been discussed as M1, M2, M3 and M4 in the above, they are all not
recognized in Ethiopian as the CBE only recognized M1 and M2.as the total Ethiopian money
supply. This is because the country’s financial markets are still not relatively developed. Another
type of money is the base money identified as M0. It comprises of all currencies in circulation
and all reserves of banks including the central bank. It is high powered money used in
creating other types of money.
2.1.3 Why Money Supply Is Important?
Because of money is used in virtually all economic transaction, it has a power full effect on
economic activity. An increase in the supply of money works both through cowering interest
`rates. Which supers investment and through putting more money in the hands of consumers
making feel wealthier and thus stimulating spending? Business firm respond to increased sales
by ordering more row materials and increasing production. The spread of business activities
increase the demand for labor and raise the demand for capital good. Opposite effects occurs
when the supply of money falls the rate of economic growth decline.
2.1.4. Monetary Policy and Macroeconomic Performance
2.1.4.1. Framework of Ethiopian Monetary Policy
Monetary policy refers to the government regulation of the money supply and the level of
interest rate. It is executed by the central bank, either in its capacity as a regulator of the financial
sector or through its participation in OMO (Open Market Operation) and government deficit
financing. Monetary policy is important because it influences the level of output, employment
and the rate of economic growth. (Saad , 2007)

In Ethiopia, the National Bank of Ethiopia (NBE) as the central bank of the country is given the
responsibility of formulating and conducting monetary policy. According to proclamation
number 591/2008 the main purpose of NBE is to maintain stable rate of price and exchange, to
foster a healthy financial system and undertake other related activities conducive to rapid
economic development. Some of the specific objectives of NBE includes; maintaining single
core digit inflation and keeping the exchange rate of birr close to the equilibrium exchange rate.
The NBE has also its own ultimate or final target, intermediate target and operating target. The
final targets of monetary policy in Ethiopia are to maintain price and exchange rate stability and
support sustainable economic growth. Whereas, intermediate targets includes those variables that
affect the ultimate objectives of monetary policy but are not under the direct control of NBE.
Most commonly used intermediate targets include monetary aggregates such as money supply or
some credit aggregates and exchange rate. The current target is to ensure that the money supply
growth is in line with nominal GDP growth rate (NBE, 2009). The use of monetary aggregates as
an intermediate targets is due to the assumption that there is a predictable relationship between
money supply and inflation, which is the final objectives of monetary policy. While using
exchange rate as intermediate targets, the bank pegs the nominal exchange rate to the currency of
a country with low inflation. The advantage of an exchange rate target is that it provides a clear
and easily monitored anchor for price expectation; however, this kind of targeting severely limits
the independence of monetary policy as the pursuit of other objectives using monetary policy
would be restricted, and furthermore, it requires maintaining fiscal discipline. (EEA, 2011)

Framework of Ethiopian Monetary Policy                                                             

Instruments includes:-
➢ OMO 
➢ Standing commercial banks credit facility, 
➢ Reserve requirement 
Operational targets
➢ The growth of base money or reserve money
Intermediate targets
➢ The growth rate of money supply in line with nominal GDP growth
Ultimate targets
➢ Exchange rate stability
➢ Price stability
➢ Support sustainable Economic Growth
Source: NBE report (2009)
On the other hand operating targets are variables that are under the control of the NBE. The
operating targets of monetary policy include reserve money targets and short term interest rate
targeting. As IMF (2005) cited in EEA (2011) in underdeveloped financial markets setting a
reserve money targets may be preferable option as linkage between short term rates and
monetary aggregates and inflation is not clearly understood. “The operational target is an
economic variable that the central bank wants to influence, largely on a day-to-day basis, through
its monetary policy instruments. They can be used to link instruments of monetary policy to
intermediate targets set by the central bank and represent the first impulse in the transmission
process of monetary policy”(NBE, 2009:3) The growth of base money/reserve money is being
used as operational target of the National Bank of Ethiopia.

2.1.4.2. Monetary Policy Instruments

On broad bases, we can classify monetary policy instruments as direct and indirect. A direct
monetary policy instrument involves giving instructions to commercial banks on their deposit
and lending activities. Most of the time they are effective but their drawbacks are they create
distortion in the economy, financial repression and financial disintermediation. Whereas, an
indirect monetary instruments involves the uses market based instruments to affect commercial
banks liquidity. Some of the direct monetary policy instruments include direct lending,
administratively set interest rate and bank-by bank credit ceiling. Whereas, indirect monetary
policy instruments include reserve requirements, OMO (Open Market Operation), central bank
standing deposit and lending Reserve money (Base money) is defined as the sum of currency in
circulation and deposits of commercial banks at NBE facilities (EEA, 2011). These instruments
are helpful to inject or absorb liquidity in the financial system.
The introduction of a wide range of monetary instruments by central banks engenders
competition, efficiency and transparency and broadens financial intermediation in the
banking system. It also promotes liquidity management of commercial banks and gradually leads
to the development of well functioning money and financial markets which could serve as
catalysts for economic growth and development.
So far, the use of such instruments has been extremely limited in Ethiopia due to the
underdevelopment of the money market and the virtual non-existence of a financial
market. Thus, it is envisaged to use a mix of diversified monetary policy instruments so as to
effectively carry out the monetary management function of the NBE.
Open Market Operation (Sale & purchase of bonds or securities issued by governments)has
generally been used by countries as one of the main instruments for the development of
money markets. Trading in these instruments liquefies the financial system in particular and the
national economy in general and increases financial intermediation among market participants.
In light of this, the NBE will use open market operations (sale and purchase of
government securities) as one of its monetary policy instruments. In the absence of its own
securities, certain amount of government treasury bills needs to be allocated to NBE by
the government for its monetary policy purpose. To prepare the ground for enhanced open
market operations, the yield on government securities should be at least close to the minimum
interest rate. As a next step, secondary market for government securities needs to be established.
A standing central bank credit facility is another instrument used to enhance the
financial capacity of commercial banks and to promote financial intermediation and efficiency.
The key advantages of such standing credit facility are transparency and predictability of
accessing central banks’ resources to cover short-term needs. This credit facility gives banks an
assurance that, when confronted with problems of shortfall in the clearing and a lack of
alternatives for raising immediate funds in the inter-bank market, they can settle the
clearing with the central bank’s funds at a reasonable interest rate which has a clear
relationship with short term market interest rates. The NBE will use this facility as one of its
monetary policy instrument.
Reserve requirement is a major policy instrument used by NBE. The bank imposes reserve
requirement on commercial banks. This instrument is effective in curtailing banks’ lending
activity. The reserve requirement was 5% before 2007 but later it was raised to 10% during this
year and latter to 15% in April 2008. The NBE also imposes liquidity requirement ratio and the
prevailing liquidity ratio is 25% (Ibid: 168-178).

The NBE can’t use OMO (Open Market Operation) as there is no secondary market in the
country. The Treasury bill is the only active primary market in the country and also used by NBE
as a monetary policy instrument. Government offers 28 days, 91 days and 182 day bills. In
general, some of the instruments used and to be used by NBE specifically includes OMO,
standing commercial banks credit facility, reserve requirement, use of selected credit control
when necessary, and moral Suasion (NBE, 2009).
2.1.4.3. Transmission Mechanism of Monetary Policy
Another aspect of monetary policy is the transmission mechanism which refers to the process
that links monetary policy actions to the ultimate objectives of monetary policy. The
transmission channels in which monetary policy can affect real economic activity includes the
credit channel, the interest rate channel, the exchange rate channel and the asset price channel
(NBE,2011).
In the case of the interest rate channel an increase in money supply lowers the real interest rate,
which in turn stimulates investment and therefore GDP (Christensen, 2011). The asset price
channel also requires the existence of secondary market for equities and real estates. In the case
of Ethiopia there exists no secondary market as a result this channel is not currently in use. The
exchange rate channel affects economic activity through its effect on interest rate. When money
supply increases nominal interest rate decreases and this in turn implies a decrease in real interest
rate. When this takes place the dollar denominated assets are less attractive which leads to a
decline in the demandfor dollars or depreciation. It is known from theory that depreciation makes
domestic goods cheaper and increase net export which is positively correlated with GDP (Akila,
2005). Finally the credit channel works through banks lending activity to the private sector
which affects investment and hence growth. In the case of Ethiopia the interest channel, the
exchange rate channel and the credit channel are used. However, underdevelopment of financial
market has got serious effect on the effectiveness of these transmission channels.
2.1.5. Monetary Policy Objective
The principal objective of the monetary policy of the National Bank of Ethiopia is to maintain
price & exchange rate stability and support sustainable economic growth of Ethiopia.
Price stability is a proxy for macroeconomic stability which is vital in private sector economic
decision on investment, consumption, international trade and saving. Finally, macroeconomic
stability fosters employment and economic growth. Maintaining exchange rate stability on the
other hand is considered as the principal policy objective of NBE so as to be competitive in the
international trade and to use exchange rate intervention as policy tools for monetary
policy to affect both foreign reserve position and domestic money supply.
More specifically, the objectives of Ethiopia’s monetary policy are to:
  Foster monetary, credit and financial conditions conducive to orderly, balanced
and sustained economic growth and development.
 Preserve the purchasing power of the national currency – ensuring that the level of
money supply is generally consistent with developments in the macro- economy
and intervening in the foreign exchange rate market for the purpose of
stabilizing the rate when conditions necessitate.
 Encourage the mobilization of domestic and foreign savings and their efficient
allocation for productive economic activities through the implementation of a
prudent market driven interest rate policy.
 Facilitate the emergence of financial and capital markets that are capable of
responding to the needs of the economy through appropriate policy measures.
These measures would ensure the gradual introduction of trading instruments on a
short-term basis.
2.1.6. Monetary Policy Strategy/Targeting Framework
Monetary policy strategy of a central bank depends on a number of factors that are unique and
contextual to the country. Given the policy objective, any good strategy depends on the
macroeconomic and the institutional structure of the economy. An important factor in this
context is the degree of openness of the economy. The more open the economy is, the more the
external sector plays a dominant role in monetary management. Within a country’s monetary
management framework, there are basically three targets: the ultimate or final target, the
intermediate target and the operating target.
2.1.6.1. Final and Intermediate targets
The final targets of monetary policy in Ethiopia are to maintain price and exchange rate stability
and support sustainable economic growth. In achieving these objectives, the NBE sets
money supply as an intermediate target. It should be noted that intermediate targets are
not directly controlled by the central bank. Traditionally, money supply is defined from its
narrow and broader sense. Narrow money (M1) is a measure of money stock intended primarily
for use in transactions. It consists of currency held by the public, traveler’s checks, demand
deposits and other checkable deposits. Broad Money (M2) is a measure of the domestic
money supply that includes M1 plus Quasi-money (savings and time deposits), overnight
repurchase agreements, and personal balances in money market accounts. Basically, M2 includes
money that can be used for spending (M1) plus items that can be quickly converted to M1. NBE
takes the broader definition of money or M2 as money supply. The current target is to
ensure that the money supply growth is in line with nominal GDP growth rate.
2.1.6.2. Operational target
The operational target is an economic variable that the central bank wants to influence, largely
on a day-to-day basis, through its monetary policy instruments. They can be used to link
instruments of monetary policy to intermediate targets set by the central bank and represent the
first impulse in the transmission process of monetary policy. The growth of base money/reserve
money is being used as operational target of the National Bank of Ethiopia. Reserve money
(Base money) is defined as the sum of currency in circulation and deposits of commercial
banksat NBE. The practice of targeting reserve money is based on the assumption that there will
be a stable money demand function in the economy. If the money demand happens to be unstable
over the medium to long term, then the NBE will shift its targeting in to another workable
framework such as interest rate targeting or multiple indicator approach
In addition, the Bank shall maintain the international reserves at a level which, in its opinion, is
adequate for Ethiopia’s international transactions. In this regard, a minimum threshold at which
foreign reserves are considered adequate is set at three months of imports of goods and services.
2.1.7. What Factors Affects the Effectiveness of Monetary Policy In Ethiopia?
There are different factors which affect the effectiveness of monetary policy in Ethiopian mainly
including the following.
 Underdeveloped financial structure; in most of rural areas there are
absence of financial institution which should be mobilized financial
resources for the success of financial market.
 High marginal propensity to import and in favorable balance of payment,
loss of international services, pressures on the exchange rate the like. The
marginal propensity to import is high while the production is concentrated
few export products.
 Inadequate bank data ; due to various institutions malfunctioning and in
efficiencies bank data on the aggregate are inadequate and most time out
dates. This policy formulation and implementation are very difficult to be
realized.
2.1.8. What Are The Determinants Of Money Supply In Ethiopia?
There are two the determination of the money supply in Ethiopia. According to the first view the
money supply is determined exogenously by the central bank. The second view holds that the
money supply is determined endogenously by changes in the economic activity which affects
people’s desire to hold currency relative to deposits, the rate of interest and like. Thus the
determinants of money supply are both endogenous and exogenous, which can be broadly
classified as:- the minimum cash reserve ratio, the level of bank reserve and desire of people to
hold currency relative to deposits. The last two determinants together are called the monetary
base or high powered of money.
2.2 Empirical literature
The empirical works of this study were conducted determining the exact relation between the
rate at which money is supplied and its influence on the general price level as well as economic
growth. Money supply plays an important role in boosting the economic growth of any country
provide money is exogenously determined in the economy. Its impact on the economy has been
widely examined in the developing and developed countries in the context of monetarist and
Keynesians controversies (Abbas and Husian, 2006). The causal relationship between money and
income and between money and price has been an important area of investigation in economics
particularly after provocation paper smiths in 1972.

The structure and trends of economic growth (1975/76-2005/06)

During the period of military government, the Ethiopia economy was characterized by erratic
nature and poor performance. Factors like the inappropriate economic policy and
mismanagement, severe drought, prolonged internal and external social and political unrest
were partly responsible for the low performance. For instance, during the Derg regime real GDP
and per capital growth rate was 1.89% and -2.2% on average respectively. This low performance
of economy is mainly due to political unrest and vagaries nature of agricultural sector which
accounts the larger share of the GDP. For example, in 1984/85, the growth rate of GDP was
declined to negative 13.87% due the occurrence severe drought and which in turn lead 21,91%
general price hike. This had created the deterioration of the standard of living during the period.
The sectoral share of agriculture in GDP is still high though the share of service sector took the
leading rank since 2008/09. In 2010/11 fiscal year, regarding sectoral development, agriculture
grew by 9 % ,industry 15 % and service 12.5 %. In this year, agriculture and allied activity
accounted for 41, industry 13.4 and service 45.6% of GDP. Similarly, agriculture contributed 4.7
industry 1.5 and service 5.3 percentage point to the 11.4 % real GDP growth in 2010/11. Sectoral
share of GDP, DP growth rate and per capital GDP growth rate over the study period are
summarized in the following table
Table 2.1: sector share and growth rate of GDP
Macro variable Dergue regime EPRDF Regime Average
(1974/75-1990/91) (1990/91-2013/14)
Share of agriculture 55.57 48.44 52
Share of industry 11.43 12.26 11.84
Share of service 32.98 39.88 36.43
sector
GDP growth rate 1.89 6.67 4.28
GDP per capital -2.2 4.55 1.18
growth rate
GDP per capital -2.2 4.55 1.18
growth rate
Source: NBE, 2011
Although the share of agriculture in GDP tended to decline over time, it still remains the largest
employer, the main source of foreign exchange, and supplier of raw material and market to
domestic industries. Moreover, as we can see from the above table, for the past four decades the
Ethiopian economy has been growing on average annual growth rate of 4.28 percent while per
capital income has been growing at annual average growth rate of 1.18 percent. From the figure
below, we can see that the growth rate Ethiopian economy has showed fluctuation during the
past four decades. This is due to many factors like internal and external unrests mainly in Dergue
regime and exogenous shocks occurred in agricultural sector. Due to agricultural vulnerability to
the vagaries of nature, this fluctuation of growth is strongly associated to the agricultural
performance which constitutes the larger share of the economy. For example, the average growth
rate over the period 1984/85 was negative 13.87 due to severe drought on agriculture.
Alemayehu (2001) put that at the period of favorable weather, growth of agriculture become high
and consequently the greater the growth of the economy.
Post- 1991period, we can witnessed the country’s revival and increasing effort to reverse the
poor performance trend of the economy that was seen in the previous regime. Regardless of
fluctuations due to recurrent drought, ethio- ertrian war (real GDP decreased by 3.46 percent)
and land degradation over the period, over all economic performance has shown relative good
progress. For example, during the period (1990/91-2011/12)the real GDP and per capital has
been grown at 6.67 and 4.55 percent. This shows, in the post 1991/92, the Ethiopian economy
revealed good performance. Particularly in the past nine years, the country achivedcontiounes the
double digit growth rate with average of 11%.in the fiscal year 2010/11,real GDP growth was
11.4% moderately higher than the previous year’s growth of 10.4 % and GDP per capital grew
8.5 %.(NBE,2011)
Das (2003) examined the long run relationship between money and output in India and provide
the evidence that money unidirectional affects output which affects growth as well. Ashra and et
al 2004 examine the relationship between money supply and economic growth for the case of
developing country and indicated that there exist bi directional causality between money and
price level and that money is not neutral so that is not exogenous in long run.
Based on an econometric financial programming model applied the data for twenty-nine
developing countries during 1976-1985 once and for all reduction of domestic credit or money
supply by 10 % lowered output by only about one half in the short run (Khar and Knignt,1982).
A study of Dorodian (1993) of 43 developing countries of which 27 are program countries that
used the IMF financial resource. During 1977 the period of observation is from 1977-1983 tried
to examine directly the effects that a typical stabilization program which includes reduction in
the growth of domestic credit and an increase in real interest rate may have negative influence on
the rate of growth of output, the inflation and the current account balance. A study of Cylfason
(1987) reviewed the relationship between money supply and economic growth and the evidence
showed that credit expansion in several non oil developing countries were reduced markedly
economic growth and the overall balance of payments improved substantially in case.
After much divergent done on the control of monetary phenomenon we were able to learn from
through reasonable and theoretical supported routes of most monetarist that on the increase in the
money stock will have little or no effect on real output and employment in the long run, but will
merely raise the price level there by resulting potential inflation (Nwobodo1973).
Asoqun (1998) examined the influence of money supply and government expenditure on gross
domestic product. He adopted the Saint Levis model on annual and quarterly time series data
from 1990-1995. The result indicated that unanticipated growth in money supply would have
positive effect on output.
A study of Clyfason (1987) received the relationship between credit policy and growth
performance as well as other relevant aspects of economic recorded under stabilization programs
supported by the IMF during 1977, 1978 and 1979. It examined whether these programs in the
enrirly have influenced growth directly or indirectly or whether other developments have
accounted for changed in the growth rate. The evidence shows that credit expansion in several
developing countries was reduced markedly and the overall balance of payments improved
substantially. At the same time the inflation rate prevailing in other developing countries. Those
results were achieved at the cost of relatively modest reduction in the average growth rate of
output during and immediately after the period.
Ogunmuyiwa and Ekone (2010) investigated the relationship between money supply and
economic growth in Nigeria by using the data for the period (1980-2006). The study employed
OLS and error correction mechanisms in order to check the relationship while changes causality
tests for checking the causality. The study found that economic growth is positively influenced
by the level of money supply in the economy. Mohammed and et al (2009) examined the long
run relationship among money supply, inflation, government spending and economic growth in
Pakistan by using annual time series data from 1977-2007. Co-integration results showed that
public expenditure and inflation has significant and negative effect while money supply has
significant and positive effect on economic growth in the long run.
Alemshet (2003)analyzed the link between money supply and economic growth in Ethiopia and
concluded that in short run increasing the money supply doesn’t have effect on the growth of
GDP whereas in the long run money supply growth significantly affects the growth rate of gross
domestic product(GDP).
 CHAPTER THREE
3. RESEARCH METODOLOGY
3.1 Source and data type

While conducting this study secondary data is employed. This secondary data is expressed
quantitatively. The data obtained from different books, magazines, journals and internets of the
authorized bodies. Time series data the data mainly collected and the data is collected from
National Bank of Ethiopia (NBE) annual report, Ministry of Finance and Economic
Development (MoFED), Central Statics Authority (CSA) and For analyzing the impacts of
money supply on economic growth in Ethiopia the data covered the period from 1974 to 2014
was collected.

3.2 Model specification

The empirical analysis would be carried out by using econometric techniques. In this study the
empirical analysis would investigate in a one stage of simple multiple regressions for analyzing
the impact of money supply on economic growth. In this study, broad money supply, inflation
rate, population growth and personal saving were include as the main determinant of economic
growth. Therefore, using the above variable the following model was (is) specified by using OLS
estimation techniques. The data (variable) were tested for stationary using Augmented Dick-
Fuller (ADF) test.

RGDP=f(M2,Ps,Inf,pop)
The above formula shows that real growth product as a function of broad money supply, personal
saving, population growth and inflation rate.
LOGRGDP=β0+β1LOGM2+β2LOGPs+β3In+β4logpop +ei

Where; LOGRGDP-logarithm of real gross domestic product

In-inflation rate
LOGPs-logarithm of personal saving
LOGM2-logarithm of broad money supply
LOGPOP-logarithm population growth
ei- error term
Β0-constant (intercept coefficient)
β1, β2, β3 and β4 are parameter estimator
The expected signs of the coefficient the parameter are β1>0, β2>0, β3<0 and β4>0

3.3 Method of data analysis

Descriptive and econometrics methods were used to analysis and interpret the data’s
quantitatively and qualitatively after editing and cross checking the data for reliability and
accuracy. In the descriptive analysis different tables, graphs and also used pie charts etc to make
it more attractive would be used to describe the data clearly. In the econometrics part after
regress the data the following testes are used.

Test for stationary: one of classical linear regressions assumptions is that the series should be
stationary in order to estimate on the base of ordinary least square (OLS) procedure. A series is
said to be stationary if its mean and variance are constant over time and the value of the variance
between time periods depends only on the distance or lag between the two time period and on the
actual period at which the covariance is computed (Gujarati 2004). Empirical studies usually use
the ADF and Philips person (PP) techniques of checking stationary. For this study it employed
ADF test and applied the test to each variable that were used in the analysis. This test is
employed because of the null hypothesis reject if t-calculate is greater than t-statics and accept
alternative hypothesis.

Test for Multicollinearity: originally it meant the existence of an exact linear relationship
among some or all explanatory variable of a regression model. In this research to test wheat there
is multicollinearity or not using the variable inflation factor (VIF).

Heteroscedasticity
Heteroscedasticity or no constant variance is tested through brush –pagan testing
method .if p –value is less than the given value of significance rejects the null –constant
variance. If p –value is greater the given level of significance not reject the null –constant

variance.
Test for Autocorrelation: term autocorrelation may be defined as correlation between numbers
of series of observation ordered in time as series data. In the regression model assumes that such
autocorrelation does not exist in the disturbance term by using Durban Watson and Ui (Gujarati,
2004). To test autocorrelation the Decision rule of autocorrelation is to accept Ho if the
probability of F-statistics and observed R2 of the intermediary equation are greater than 0.05
which depict the absence of autocorrelation. On the other hand H1 is not rejected, if the
probabilities of F- statistics and R2 of the intermediary equation are less than 0.05. R2 value: R2
measures the proportion of the variation in the dependent variable accounted for the explanation
in the dependent variable accounted for the explanatory variable. If the value of R2 is greater than
0.5 or 50% is the higher the fitness of the model, but, the value of R2 is less than 0.5 is not good
fitness of the model

Test of co integration: Test of co integration is use for checking whether the linear
combination of the variable is also stationary or not. Having the tests our time series analysis
testing for co integration which amount to check whether the linear combination of the
variable is stationary. Co –integration test to carry out the study we will run OLS regression at
level and then we will store the residual and test it is stationary based on augmented dickey -
fuller test.

3.4. Description of variables

 The dependent variables

Real GDP:- is the proxy variable for economic growth which represent the amount of goods and
services produced by an economy in a year. It is conventionally measured as the percentage rate
of increase in real gross domestic product or real GDP.

 Independent variable

Personal saving:-the amount of money that an individual has put away for non-immediate use,
for example one may utilize personal saving to save funds for an expense purchase such as a.
then the saving rate raises, consumption and the price level both decline. It leads to sufficient
investment to economic growth of the country. Then the sign that the researcher expected here is
positive.

Population growth: different empirical studies tell that population growth correlated with
economic growth differently in different country. There is also a debate about how population is
change affects economic and social development in social science on one hand, there has been
the Malthusians view that emphasize the negative effect of population growth.
Money supply :- is important for financial development. Development in financial sector is
positively linked with economic growth. It is defined as a collection of liquid asset that is
generally accepted that as a medium of exchange and for repayment of debt. In that role it serves
to economize on the use of scarce resources devoted to exchange, expand resource for
production, for expand ( promote investment, expand for public services like that of road, health
service and education and also accelerate trade promote specialization and contributes to the
society welfare. It leads to economic growth then the sign that the researcher expects her is
positive. And it measured by M1 plus saving deposit plus time deposit (M2=M1+SD+TD).
Where M1= narrow money supply, M2= broad money supply, SD= saving deposit and TD= time
deposit.

Inflation:-it is a sustained increase in the general level of prices. A one of increase in the general
price level or sustained increase in just small number of prices does not constitute inflation or in
other words inflation may be defined as persistent fall in purchasing power of money. This lead
to difficulty for purchasing raw materials for insistent and also it is difficult for consumption.
Without expanding investment there is not job opportunity for unemployment this shows that
there is no economic growth (Mankiw2002). But according to the idea of Fischer (1979) has
shown that the rate of capital accumulation is not invariant to the rate of monetary growth and
that investment and inflation are related positively in the short run. It means that when economic
growth shows by some amount it lead to inflation. Then I will support the idea of Fischer about
inflation and economic growth has a positive relation. So the researcher expects here is positive.
Random term: these are terms which include other determinants variables that are not included in
the specified period. It measured by consumer price index (CPI).

3.5. Statement of Hypothesis

The study tested the following hypothesis in order to analyze the impact of money supply on
economic growth in Ethiopia.
Hypothesis 1
H 1.0: Inflation rate has negative impact on economic growth.
Hypothesis 2
H 2.0: population growth has positive impact on economic growth.
Hypothesis 3
H 3.0: Broad money supply has positive impact on economic growth.
Hypothesis 4
H 4.0: Personal saving has positive impact on economic growth.

CHAPTER FOUR
4. Data analysis and presentation
4.1. Descriptive analysis of Ethiopia economy
4.1.1 Trends in economic growth and money supply
This section mainly focuses on assessing the growth performance of the Ethiopian economy in
the period by analyzing the growth rate of real GDP and broad money supply during (1974-
2014). And it tries to link the growth of real GDP and inflation rate and population growth and
personal saving. During the period under consideration, (1974-2014) the annual average amount
of real GDP was 4.86522991 and the annual average amount of broad money supply was
4.89163 in this period the Ethiopian economy has undergone two major shifts in polices.

The period from 1974-1991 was under the regime of derg under the frame work of Marxian-
Neo-Marxian development model and central planning system that discouraged a market
economy and privet property , land and medium and large enterprise were nationalized. In this
period the real GDP experiences tremendous fluctuations. The peak during this regime
frequently recovers from recession rather than actual boom. The average annual amount of real
GDP under this regime was 4.650896405. While the average annual amount of broad money
supply during the same period was 4.22130218. During this regime amount of money supply
rises faster than real GDP. The highest amount of real GDP was achieved during 1990 with the
amount 4.693103192. This amount was also accompanied by 4.4732548 amount in broad money
supply, 20.896% growth rate in inflation and 3.472024698 in personal saving.
The period from 1992-2014 was under the regime of EPRDF, which has focused on reorienting
the economy trough the market reforms including a structural adjustment program. As a result
the state is direct role in economic activity has declined. The government adopted agricultural
led industrialization as a central bank of its program with a focus productivity growth on small
farms and labor intensive industrialization. Under this period the country has achieved
4.949099548 average annual real GDP. While the amount of broad money supply during this
period is 5.00193141 .its witnessed that the amount of broad money supply is faster rise than the
amount of real GDP.

Descriptive analysis

Table 4.1 descriptive statistic of RGDP, M2, PS, INF and population growth
Variable LOGRGDP LOGM2 LOGPS INF LOGPOP
 Mean  4.817276  4.890085  3.539619  9.583195  7.753907
 Maximum  5.301250  0.953057  4.384809  36.40000  8.975459
 Minimum  4.562010  0.871907  2.699439 -9.146000  7.433003
 Std. Dev.  0.232825  0.013630  0.521860  9.578530  0.255298
Obse. 41 41 41 41 41

Source:- Our Eview6 computation

From the above table we can observe that RGDP in the past 41 years was about 4.86523 and its
value deviates from the mean by 0.232825. the standard deviation the variation in inflation,
personal saving, broad money supply and population growth the measurement of the variables
are unit and percent.
The average mean of the broad money supply throughout the 41 years was 4.891628 with
standard deviation of 0.013630 which shows the variations of broad money supply from its
mean. The mean value of personal saving is 3.539619 with standard deviation 0.521860 which
shows the variation of personal saving from the mean. The mean value of inflation 9.583195
with the standard deviation 9. 578530 the variation of inflation from the mean. The mean value
of rainfall population growth with standard deviation 0.255298 which shows the variation from
its mean. Under the study year the variation of broad money supply is higher than other
explanatory variables which include personal saving, inflation rate and annual population
growth.
Figure 4.1 the trends of real gross domestic product (RGDP) from the period
(1974-2014) This graph shows that RGDP increases from time to time and highly
increases in our country Ethiopia.
LOGRGDP
5.4

5.3

5.2

5.1

5.0

4.9

4.8

4.7

4.6

4.5
1975 1980 1985 1990 1995 2000 2005 2010

Source: Owen our Eview6 computation

Figure 4.2 the trends in broad money supply in Ethiopia from the period (1974-
2014)
This trend shows highly increase in broad money supply from time to time. This
means that our countries supply of money increase from past than present.
 LOGM2
6.0

5.5

5.0

4.5

4.0

3.5

3.0
1975 1980 1985 1990 1995 2000 2005 2010

Source: Owen ourEview6 computation

Figure 4.3 trends in inflation rate in Ethiopia from the period (1974-2014)
INF
40

30

20

10

-10
1975 1980 1985 1990 1995 2000 2005 2010

Source: Owen our Eview6 computation

means in 2011 the inflation rate reaches high and the government takes some measurement and
The inflation rate in Ethiopia is increases from time to time the economy as increases.
Figure 4.4 the trends in personal saving in Ethiopia from the period (1974-2014)
The trend in personal saving increases highly. In Ethiopia annual report of the NBE and other
financial sector the saving account increases time to time.
LOGPS
4.4

4.0

3.6

3.2

2.8

2.4
1975 1980 1985 1990 1995 2000 2005 2010

Source: Owen our Eview6 computation

Figure4.4 shows that real GDP growth is highly dependent on population growth.
The graph shows that an increment of population growth from time to time as results RGDP
increase time to time.
LOGPOP
9.0

8.8

8.6

8.4

8.2

8.0

7.8

7.6

7.4
1975 1980 1985 1990 1995 2000 2005 2010
 4.2 Econometrics Analysis
Test for stationary

As it was explained in the methodology part of the paper, ADF test was used to test whether the
variables are stationary or not. ADF test helps to determine at what order of integration the
variable because stationary and the length of lag as well.
Table 4.2 Stationary test results

Dickey-Fuller test for LOGRGDP

sample size = 1974-2014
unit-root null hypothesis: a = 1

Variable Test of t-statistics 1% critical 5% critical 10% p-value

stationar value value critical
y value
LOGRGDP d(1) -5.114968)*** -3.610453 -2.938987 -2.607932 0.0001
LOGM2 d(1) (-8.092921)*** -3.615588 -2.941145 -2.609066 0.0000
LOGPS d(0) (-4.428472)*** -4.205004 -3.526609 -3.194611 0.0056
INF d(0) (-4.319105)*** -3.605593 -2.936942 -2.606857 0.0014
LOGPOP d(0) (-6.972280)*** -4.205004 -5.26609 -3.194611 0.0000

Source :- Eview6 result computation

Where LOGRGDP is the natural log of real gross domestic product, LOGM2 is the natural log of
broad money supply, LOGPs is the natural log of personal saving, LOGPOP population growth
and INF is inflation rate. ***, ** and * are significance level at 1%, 5 % and 10%, respectively.
And the value in () indicate the lag.
Firstly; we can see from the above table, the dependant variable RGDP and independent
variables broad money supply are stationary (first difference and intercept) at 1% , 5 percent
and 10 percent level of significant and significant. , since absolute value of t-statistics(-
8.092921) is greater than absolute value of t-critical value of 1%, 5% and 10%(-3.615588,
-2.941145 and -2.609066 respectively), And also as we can see from above table p-value shows
that there is high significance relationship between RGDP and money supply, since p-
value(0.0056) is less than 0.01.
Secondly; we can see from above table ,the dependent variable RGDP and independent variable
personal saving are stationary (level and intercept) at 1%, 5% and 10% level of significance ,
since absolute value of t-statistics(-8.092921 ) is greater than absolute value of t-critical value
of 1%, 5% and10%(-4.205004,-3526609 and -3.194611 respectively),
And also as we can see from above table p-value shows that there is high significance
relationship between RGDP and personal saving, since p-value(0.0000) is less than 0.01.

The other point seen from above table , the dependent variable RGDP and independent
variable inflation rate are stationary (level and intercept ) at 1%, 5% and 10%level of
significance, Since absolute value of t- statistics (-4.319105) is greater than absolute value of
t-critical value of 1%, 5% and 10%(-3.605593, -2.936942 and -2.606857 respectively ) level of
significance. And p-value shows that there is high significance relationship between RGDP and
inflation rate ,since p-value (0.0014)less than 0.01.

Finally; to the above points we seen from the above table the dependent variable RGDP and
population growth are stationary (at level trend and intercept) at 1%, 5% and 10% level of
significance, since absolute value of t-statistics (-6.972280) is greater than absolute value of t-
critical value of 1%, 5% and 10% (-4.205004,-3.526609 and -3.194611 respectively )level of
significance and p-value shows that there is high significance relationship between RGDP and
population growth, because-value(0.0000) less than 0.01.

Generally, the above table shows that there is and the relationship between Dependent variable
(rgdp) and explanatory variable (ps, pop ,inf, and m2).

Regression Results of the Model

The Eview6 result shows that broad money supply, personal saving, inflation and population
growth have positive relationship with real GDP.
Table 4.3. Eviews6 Result for the estimated model

LOGRGD Coef. Std. Err. t-statistics Prob

CONS 0.052493 1.028829 0.051022 0.9596
LOG
M2 2.524097 1.201648 2.100529 0.0428
LOGP
s 0.292450 0.037898 7.716799 0.0000
INF 0.002595 0.001088 2.385498 0.0224
LOGP
OP 0.188047 0.062155 3.025459 0.0046
F( 4, 36) = 123.03
Prob > F = 0.0000
R-squared = 0.93
Adj R-squared = 0.92

Source: - Our Eviews6 regress for analysis

Then after regression the estimated model would be looks like the following:

Log rgdp=0.0524493 +2.5240967logm2+0.292450logps+0.002595inf+0.188047logpop

+ei
The result shows that there is a positive relationship between broad money supply, inflation
rate, population growth and personal saving with that of the dependent variable real GDP.
Broad money supply: - there is a positive and significant relationship between money supply and
real GDP both at 1%, 5% and 10 percent level of significance. The coefficient of money supply
is 2.52409654039 implies that other explanatory or independent variables being constant a one
percent increase in broad money supply to increase real GDP by 2.52409654039 percent.
 Personal saving:- there is a positive relationship between personal saving and real GDP. The
coefficient of personal saving is 0.292449756 shows that the other variable being constant a one
percent increase in personal saving will increase real GDP by 0.92449756 percent. This
explanatory variable is significant at 1 percent level of significance.

Inflation rate :- there is positive relationship between inflation rate and real GDP the coefficient
of inflation rate is 0.002595 shows that other variable being constant

Population growth:- in this regression there is a positive relationship between population growth
and real gross domestic product (RGDP). The coefficient of population is 0.188046597128 it
shows on the assumption that other things remain constant population increased by one percent
to increase real GDP by 0.188046597128 percent. This variable is significance at 1 percent level
significance.
Table 4.4 Summary of prior sign

Variable Expected Obtained Correlation

M2 Positive Positive Conform
PS Positive Positive Conform
In Negative Positive Not Conform
POP Positive Positive Conform

The co-Efficient of Multiple Determinations (R2)

This is used to test the goodness of fit of the model from the regression results. The value of R 2 is
93 percent implies that in the long run 93 percent of the variation in RGDP is explained by the
independent variables of broad money supply, inflation rate, personal saving and population
growth. The remaining 7 percent of RGDP is explained by the independent variables which are
not included in the model. Adjusted R2 which is preferable than R2 squared measures the net
impact of independent variable. The result shows that adjusted R2 is 92 percent which implies
that the explanatory variables broad money supply, inflation rate, personal saving and population
growth could be explained the dependent variable (RGDP).
Multicollinearity test
The larger the value of VIF or if the value of VIF of a variable exceeds 10 and the value of
tolerance is greater than 90 percent, the more will be the degree of co linearity that variable has
with the other explanatory variables. On the other hand the value of tolerance less than 90percent
and the value of VIF are less than 10 should be taken as a rule of thumb to show the absence of
serious multicollinearity problem is tolerable among explanatory variables(Guajarati 2004,PP
339-360).
Table 4.5 Multicolinarity test
Variable VIF 1/VIF
LOGPS 3.81 0.262414
LOGM2 2.61 0.382602
LOGPOP 2.45 0.407645
INF 1.06 0.945615
Mean VIF 2.48

From the above table the values of the mean VIF for the independent variables are less than 10
that is 2.48 and the tolerance is less than 90%. Then we can conclude that there is no serious
multicollinearity problem.
Overall F-test
The overall F-test is used to test the overall significance of variable (the model). If the calculated
value is greater than four then the explanatory variable, which indicates are jointly indicate
statistically significant and explained the dependent variable (by the rule of thumb). Hence the
result shows F>4 that is 123.03>4 implies that statically significance of the model.

F( 4, 36) = 123.03
Prob > F = 0.0000
Test for Autocorrelation

The term autocorrelation may be defined as the correlation among numbers of series observation
ordered in time as time series data. In the regression context, the classical linear regression
model assumes that such autocorrelation does not exist in the disturbance term (Gujarati, 2004).
To test autocorrelation the researcher used the Breusch-Godfrey LM test for autocorrelation.

Decision rule LM test is when prob is insignificant at 1% level then there is serial
autocorrelation. The prob (0.0384) is less than 1% level of significant. From the above
conditions we can conclude that there is no autocorrelation.

Breusch-Godfrey LM test for autocorrelation

---------------------------------------------------------------------------
lags(p) | chi2 df Prob > chi2
-------------+-------------------------------------------------------------
1 | 4.289 1 0.0384
---------------------------------------------------------------------------
H0: no serial correlation
Therefore, we can conclude from the test result from the above that as the vlu of chi 2 is greater
than prob then there is no autocorrelation problem 0.01.

Hetrosedasticity test
Breusch-Pagan / Cook-Weisberg test for heteroskedasticity
 Ho: Constant variance
Variables: fitted values of logrgdp

chi2(1) = 3.41
Prob > chi2 = 0.0648
From this we can conclude that there is no heteroscedasiticty problem because the probability of
F-statistics and observed chi2 are greater than 0.05 or 5%.

Test of co integration
Test of co integration is use for checking whether the linear combination of the variable is also
stationary or not. Having the tests our time series analysis is testing for cointegration which
amount to check whether the linear combination of the variable is stationary. Co –integration test
to carry out the study we will run OLS regression at level and then we will store the residual and
test it is stationary based on augmented dickey - fuller test.
Table 4.6 shows co integration results
Lag t-statistics 1% 5% 10%
Level and -4.051580*** -3.605593 -2.936942 -2.606857
intercept
Level and -4.014362** -4.205008 -3.526609 -3.194611
trend and
intercept
Level and -4.119783*** -2.624057 -1.949319 -1.611711
none

From above table we can conclude that the dependent(rgdp) and explanatory (m2, ps, inf pop)
variable are co integrated, since the linear combination of above variable stationary. means
that ,at level and intercept stationary at 1%, 5% and 10%level of significance, at level trend and
intercept stationary at 5% and 10% level of significance ,at level and none at 1%, 5%and10%
level of significance. From the above *** ,** and* shows 1% ,5% and10% level of stationary
respectively .
 CHAPTER 5
CONCULUSION AND RECOMMONDATION
5.1 conclusions

The findings of the study shows us that in the short run economic growth is directly linked with
money supply. Therefore the monetarists argument increases money supply has some case hold
but not by the same amount. And the amount of money supply increment in Ethiopian economy
has great impact on real GDP.

Our findings proved that money supply amount is significantly affects real GDP. Thus, the
increase in money supply will stimulate productivity and stimulate economic growth. This shows
that to achieve economic growth, it also necessitates structural and institutional transformations
which could go hand in hand with the development of the monetary system.

The econometric part of this study employed multiple linear regression model (OLS). RGDP is
used as a proxy for economic growth and used as the dependent variable in the model, broad
money supply (LOGM2), personal saving (LOGPs), inflation rate (In) and population growth
(LOGPOP) are used as explanatory variable.

In this econometrics analysis the impact of broad money supply, inflation, personal saving and
population growth on real gross domestic product were positive. Broad money supply, personal
saving, inflation rate and population growth have positive impact and statistically significant
these means broad money supply and personal saving is highly relate with that of RGDP. Broad
money supply increase real gross domestic product will increase. Then we conclude that broad
money supply is positive impact on economic growth.

When we look at the performance of the economy during the military regime, it was not that
appealing. The average amount of RGDP for the entire period 1974-1991 was 4.651. And in the
same period the amount of RGDP was highest in 1991 it was recorded 4.693, on the contrary the
minimum was 4.562 in 19. The country has undergone a lot of changes since post 1991. In terms
of economic policy, a shift is made from centralized and planned economic system to more of
market driven economic system. Compared with the military regime, the Ethiopian economy,
after the coming of the EPRDF to power, was performing better. For instance the average
amount of RGDP for the period between 1992 and 2014 was 4.95 per year.

And when we look at the variable during derg regime money supply in this period was low for
comparing that of EPRDF. During military regime from the entire period the average amount of
broad money supply, personal saving was 4.22, 3.325 and average inflation rate in the entire was
6.217%.

5.2. Recommendation

Given the potential of monetary policy in promoting economic growth in Ethiopia or the impact
of money supply on economic growth in Ethiopia it is better to recommend on the following
points:

➢ Government should support personal saving by promoting (expanding) small financial

institutions in all rural areas in order to create saving habit which can have direct impact
on investment activities and, reduce unemployment rate or finally promotes real GDP in
Ethiopia. This can be done via creating knowhow to the society or by teaching about the
advantage of saving in rural and semi urban areas.

➢ Since our economy largely depends on agricultural products then, government policy
should encourage transfer from agriculture in to industrialization to increase real GDP.
The government should to promote agriculture led industrialization and also facilitate
well developed agricultural machineries, diversified seeds and develop the awareness of
the society in usage of fertilizer and purified seeds and pesticides.
➢ The government should be promoting expansionary monetary policy. These means the
government either increase the amount of broad money supply or reducing interest rate.
This is because eventually economic theory suppress that an increase in money supply
could leads to inflationary pressure in another study. Our finding revealed that the impact
of inflation on economic growth found to be statistically insignificant.
Reference
Alemayhu Gada, (2008), Macroeconomic Performance in Post- Derg Ethiopia, 8(1):159-204
Addis Ababa University
Alemshet, (2003), Analyze the link between money supply and economic growth in Ethiopia
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MoFED (2013), Ethiopia’s Progress Towards Eradicating Poverty: An interim Report on
Poverty Analysis Study (2010/11), Addis Ababa, Ethiopia.
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Masters Thesis, University of Oslo, Norway.

APENDIX

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Notes:
1. (/v# option or -set maxvar-) 5000 maximum variables

Checking for updates...

(contacting http://www.stata.com)
host not found
http://www.stata.com did not respond or is not a valid update site
unable to check for update; verify Internet settings are correct.

. *(6 variables, 41 observations pasted into data editor)

. tsset year, yearly

time variable: year, 1974 to 2014
delta: 1 year

. reg logrgdp logm2 logps inf logpop

Source | SS df MS Number of obs = 41

-------------+------------------------------ F( 4, 36) = 123.03
Model | 2.02049408 4 .50512352 Prob > F = 0.0000
Residual | .14780428 36 .004105674 R-squared = 0.9318
-------------+------------------------------ Adj R-squared = 0.9243
Total | 2.16829836 40 .054207459 Root MSE = .06408

------------------------------------------------------------------------------
logrgdp | Coef. Std. Err. t P>|t| [95% Conf. Interval]
-------------+----------------------------------------------------------------
logm2 | 2.524093 1.201649 2.10 0.043 .0870366 4.96115
logps | .2924498 .0378978 7.72 0.000 .2155895 .3693102
inf | .0025947 .0010877 2.39 0.022 .0003887 .0048006
logpop | .1880467 .0621547 3.03 0.005 .0619911 .3141024
_cons | .0524947 1.02883 0.05 0.960 -2.034069 2.139058
------------------------------------------------------------------------------

. hettest

Breusch-Pagan / Cook-Weisberg test for heteroskedasticity

Ho: Constant variance
Variables: fitted values of logrgdp

chi2(1) = 3.41
Prob > chi2 = 0.0648

. vif

Variable | VIF 1/VIF

-------------+----------------------
 logps | 3.81 0.262414
logm2 | 2.61 0.382602
logpop | 2.45 0.407645
inf | 1.06 0.945615
-------------+----------------------
Mean VIF | 2.48
Gdp

t-Statistic   Prob.*

Augmented Dickey-Fuller test statistic -5.114968  0.0001

Test critical values: 1% level -3.610453
5% level -2.938987
10% level -2.607932

M2
t-Statistic   Prob.*

Augmented Dickey-Fuller test statistic -8.092921  0.0000

Test critical values: 1% level -3.615588
5% level -2.941145
10% level -2.609066

ps

t-Statistic   Prob.*

Augmented Dickey-Fuller test statistic -4.428472  0.0056

Test critical values: 1% level -4.205004
5% level -3.526609
10% level -3.194611

inf
at level and intercept

t-Statistic   Prob.*

Augmented Dickey-Fuller test statistic -4.319105  0.0014

Test critical values: 1% level -3.605593
5% level -2.936942
10% level -2.606857

pop
at level and trend and intercept

t-Statistic   Prob.*

Augmented Dickey-Fuller test statistic -6.972280  0.0000

Test critical values: 1% level -4.205004
5% level -3.526609
10% level -3.194611

co integration

t-Statistic   Prob.*

Augmented Dickey-Fuller test statistic -4.051580  0.0030

Test critical values: 1% level -3.605593
5% level -2.936942
10% level -2.606857

t-Statistic   Prob.*

Augmented Dickey-Fuller test statistic -4.014362  0.0161

Test critical values: 1% level -4.205004
5% level -3.526609
10% level -3.194611

t-Statistic   Prob.*

Augmented Dickey-Fuller test statistic -4.119783  0.0001

Test critical values: 1% level -2.624057
5% level -1.949319
10% level -1.611711