Inflation, exchange rate, and economic growth in Ethiopia: a time series analysis

ed
By:

Mansoor Maitah1 (Professor)

iew
Karel Malec2 (Ph.D.)

Stanislav Rojik3 (Ph.D.)

Abebe Aragaw4 (Ph.D.)

r ev
er
pe
ot
tn
rin
ep

1 Professor at Czech university of life science, Czech Republic. Email Address: maitah@pef.czu.cz
2 Assistant professor at Czech university of life science, Czech Republic. Email Address: maleck@pef.czu.cz
3 Assistant professor at Czech university of life science, Czech Republic. Email Address: rojiks@pef.czu.cz
Pr

4 Assistant Professor at Woldia University, Ethiopia. Email Address: aderbie@wldu.edu.et

This preprint research paper has not been peer reviewed. Electronic copy available at: https://ssrn.com/abstract=4473206
 Inflation, exchange rate, and economic growth in Ethiopia: a time series analysis

ed
iew
Abstract

This study aims to investigate the dynamic relationship between inflation, exchange rate, and economic
growth in Ethiopia for the period 1991–2020. This is because of rampant inflation, continuously
devalued domestic currency, and the declining growth rate of the country due to violent conflicts. The

ev
study uses the ARDL model for short-run and long-run dynamics, the Bound test of co-integration to
confirm if the target variables go together or not, and Granger causality tests are performed to detect
dynamic effects. The ARDL model estimates suggested that inflation and exchange rate are negatively

r
related to economic growth. This implies that an increase in the price level reduces the production of

er
goods and services, while devaluation has a negative impact by reducing imports of intermediate goods.
Thus, increasing domestic resource mobilization, improving regulatory quality, and deepening the
financial sector can be viewed as solutions to decrease chronic foreign exchange shortages, lower
pe
inflation, and boost economic growth rates.

Keywords: inflation, exchange rate, economic growth

ot
tn
rin
ep
Pr

This preprint research paper has not been peer reviewed. Electronic copy available at: https://ssrn.com/abstract=4473206
 1. Introduction

ed
In both theory and empirical evidence, the relationship between inflation, the exchange rate, and
economic growth are ambiguous. This could be because these macroeconomic variables are influenced
by several other variables. Inflation, for example, may be caused by momentum inflation, output

iew
deviations from the natural level, and supply side factors, which have different policy implications
(Singh, et al.,., 2011). Theoretically, the cause of inflation is a contentious subject. Classical economists
believe that inflation is caused by an excessive money supply; Keynesians believes in aggregate
expenditure; monetarists believe in money supply growth; whereas Mundell-Fleming argued for

ev
imported inflation via exchange rate devaluation. The exchange rate is also affected by monetary and
macroeconomic factors that can be attributed to the domestic economy and international
developments. Moreover, a country's economic growth can be derived from various economic sectors,

r
each of which plays a different role in the overall economy. As a result, various theoretical explanations

er
have been given for the relationships between these variables.

The debates on the relationship between inflation, exchange rate, and economic growth have also
pe
continued to date. Some empirical studies found a positive relationship between the exchange rate and
inflation (Ebiringa, et al., 2014; Madesha, et al., 2017) and others found no relationship (Khan, Sattar,
and Rehman, 2012). Similarly, the relationships between inflation and economic growth have shown
controversial results. The studies made by Christen and Kofi (2009) and Ijaz, U. (2021) showed the
ot

existence of a positive and long-run relationship between inflation and economic growth. However, the
studies made by Fischer (1993), Ayyoub and Chaudhry (2011), Farooq (2011), and Kibria et al., (2014)
tn

revealed a negative relationship between inflation and economic growth. In addition, Johnson, H. G.,
(1967) and Manamperi, N. (2014) found no conclusive empirical evidence for either a positive or a
negative association between inflation and economic growth in developing countries and BRICS,
respectively. Finally, studies ( Durevall, D. & Sjö, B., 2012; Wollie, G., 2018; Yismaw, T. G., 2019; Kayamo,
rin

S. E., 2021; Nguse, T., et al., 2021) conducted in the study area Ethiopia had also shown inconclusive
results on the relationship among these variables.
ep

Therefore, there is no theoretical or empirical agreement on the relationship between inflation,

exchange rate, and economic growth. On top of that, in the case study of Ethiopia, the national bank of
Ethiopia embarked on the continues devaluation of the Ethiopian birr while there is an argument that
Pr

the real exchange rate is higher and that an overvalued currency has manifested itself in the acute
foreign exchange crunch, currency rationing, and budget deficits (Gebregziabher, F. H., 2019). For that

This preprint research paper has not been peer reviewed. Electronic copy available at: https://ssrn.com/abstract=4473206
 matter, a nominal devaluation must be accompanied by a tightening monetary policy to contain

ed
inflation. Otherwise, devaluation is not a panacea for all macroeconomic problems because exports can
be sluggish due to supply-side factors. Despite the ongoing devaluation of the currency, there is
excessive inflation and declining economic growth. Statistically, the country's inflation rate was 8.6% in

iew
1996 and increased to 26.8% in 2021. However, the inflation rate decreased to 6.9% in 2014, gradually
increased at a higher rate, and reached 35% in 2022 (WDI, 2023). These all necessitate a further
investigation of the relationship between inflation, exchange rate, and economic growth in developing
countries, particularly in Ethiopia. For this purpose, this study uses time series data on significant

ev
macroeconomic variables from 1991 to 2020.

2. Review of literature

r
2.1. Theoretical literature

The inquiry about inflation has been as old as the history of money. Many scholars have worked since

er
then to discover the cause and effect of inflation on economic growth. Despite their efforts, economists
remain in debate. Thus, this section explores the theoretical relationship that exists among inflation,
pe
exchange rate, and economic growth. In doing so, the classical economists, Keynesians, monetarists, and
at last the Mundell and Flemming are the targets.

First, for classical economic theory, the amount of labor, capital, and land used to produce goods and
ot

services determines the economy's overall output. As a result, increases in land size, investment, and
population growth all contributed to output growth by raising overall productivity. While inflation rises if
the money grows faster than the economy's real GDP. Second, the Keynesians assume that the upward
tn

Aggregate Supply (AS) curves illustrate the short-run and long-run relationships between inflation and
economic growth. The upward sloping aggregate supply curve implies that any demand side shocks not
only affect prices but also real variables such as output (Dornbush, etal,1996).The dynamic adjustment
rin

of the short-run Aggregate Demand (AD) and Aggregate Supply (AS) curves yield an adjustment path
which exhibits an initial positive relationship between inflation and economic growth. Third, according
to the quantity theory of the monetarists the long-run output is determined totally by the change in real
ep

variables such as increase in the labor force, capital input and through the improvement in the way of
production. Friedman (1969) had explained the relationship among money supply (𝑀), price (𝑃),
Transactions (𝑇), and velocity of money (𝑉) using fisher equation of exchange.
Pr

𝑀𝑉 = 𝑃𝑇 - - - - - - - - - - - -(𝑖)

This preprint research paper has not been peer reviewed. Electronic copy available at: https://ssrn.com/abstract=4473206
 Friedman assumed constant velocity and full employment in the economy. Monetarist suggested that in

ed
the long-run expansionary monetary policy affects only the price level but the not the level of real GDP
in the economy. According to monetarists argument money is neutral in affecting output in the long-
run. Economists call this concept neutrality of money. Super neutrality of money holds when all real

iew
variables including the level of GDP are independent from money in the long-run. If the hypothesis of
super neutrality of money held it would imply that inflation is harmless. However, in reality inflation has
real impact on capital accumulation, investment, and export of the country (Gokal, V., & Hanif, S., 2004).
Finally, Mundell and Flemming (1960) argued that devaluation of currency may lead fiscal deficit,

ev
inflation and balance of payments disequilibria if it is not well managed. Developing countries are highly
dependent on both investment and durable consumption commodities. He asserted that a fall in the
external value of a country’s currency either through a devaluation or depreciation will eventually lead

r
higher domestic price and worsening current account balance which inhibits economic growth of
respective country. Following the explained theoretical literature a number of empirical researches are

2.2. Empirical Literature

er
conducted and placed in any of the umbrellas. The next section presents results of the empirical studies.
pe
In 1970s, many countries mainly in Latin America experienced hyperinflation. This led to numerous
empirical studies to investigate the very cause of inflation, policy implications and its relationship with
economic growth. That was the seedbed for monetarists. However the cause and policy implications
ot

had showed variation among the studies across the countries. These findings had also opened a new
paradigm on the relationship among inflation, exchange rate and economic growth. Fischer (1993) had
tn

investigated the relationship between inflation and economic growth by pooling cross sectional and
time series data. He had employed regressions analysis for large set of 4 countries. Based on empirical
investigation he found a negative correlation between inflation and economic growth. Thus, he argued
that inflation restricts the efficient allocation of resources by obscuring the signaling role of relative
rin

price changes.

While Khan and Senhadji (2001) used non linear and unbalanced panel unlike Fischer (1993) ; with 140
ep

countries for 40 years to estimate the threshold for industrial and developing countries. Using the non-
linear least square method (NNLS) estimation techniques, they obtained the threshold levels of inflation
rate for industrial and developing countries which are 1-3% and 11-12%, respectively. Ahortor, C. R., &
Pr

Adenutsi, D. E (2009) analyzed interrelationship among inflation, capital accumulation and economic
growth in import dependent countries over the period from 1970- 2006. The data set incorporated 30

This preprint research paper has not been peer reviewed. Electronic copy available at: https://ssrn.com/abstract=4473206
 import dependent countries from different parts of the world. They used a dynamic general equilibrium

ed
and a vector autoregressive (VAR) econometric model. Their study found that capital accumulation and
economic growth have long-run negative impacts on inflation. Broad money supply and import
dependency ratio had positive long run impacts on inflation. They also found that inflation and capital

iew
accumulation had significant and positive impacts on economic growth in the long-run. Tabi, H. N., &
Ondoa, H. A. (2011) also estimated a tri-variate model which includes three macroeconomic variables
such as broad money supply, consumer price index and real gross domestic product (GDP). The model
results indicated that in Cameroon, money supply can boost economic growth but inflation was not the

ev
major determinant of economic growth.

Madesha, et al., (2013) analyzed the empirical relationship between exchange rate and inflation in
Zimbabwe for the period of 1980 to 2007. They used Granger Causality test. The result of their study had

r
indicated that exchange rate and inflation had long run relationship. On the other hand, inflation and

er
exchange rate are found to Granger-cause each other during the period under consideration. Ebiringa,
et al., (2014) explores the interrelationships among exchange rates, interest rate and inflation in Nigeria
using autoregressive distributed lag (ARDL) approach 6 for the period of 1971 to 2010. Their study had
pe
revealed positive and significant short-run and long-run relationship between inflation and exchange
rate, while Khan, et al., (2012) found no causality between inflation and exchange rate in Pakistan. In
other words, there is no long-run equilibrium relationship between exchange rate and inflation.
ot

At last the empirical studies which can partly explain the relationship among inflation, exchange rate
and economic growth in Ethiopia are the following. Tafere, K. (2008) analyzed the sources of the
tn

inflationary experiences in Ethiopia from 1996–2006. To evaluate the causes of food and non-food
inflation in Ethiopia, the two sector VAR model is used. According to the findings, real GDP, anticipated
inflation, real broad money supply, and global food prices all have a positive and significant impact on
rin

food price inflation. The model also discovered a correlation between non-food inflation and the
interest rate, real broad money supply growth, and inflation expectations. Muche (2007) applied a
structural vector autoregressive (SVAR) model to two variables: real outputs and the consumer price
ep

index (CPI). He attempted to demonstrate the impact of demand and supply shocks on real output in
order to determine which shocks are causing the current inflation. He found that in recent periods
inflation in Ethiopia is mainly driven by demand factors. Using monthly data, Loening, J., et al (2009) also
Pr

estimated error correction models for cereal, food, and non-food consumer prices as well as the CPI to
analyze the factors that contribute to Ethiopia's current inflation. They found that inflation in Ethiopia is

This preprint research paper has not been peer reviewed. Electronic copy available at: https://ssrn.com/abstract=4473206
 explained by a combination of cereal prices, food prices, and non food prices. In conclusion, in a long run

ed
the main factors that determine inflation are exchange rate and international food and noon food
prices, while in a short run it is related with momentum inflation and supply shocks.
3. Methodology of the study

iew
3.1. Data and econometric model specification

To achieve the aim of the study, the paper principally employed time series data ranging from 1991 up
to 2020. The data is compiled from a variety of sources, including the National Bank of Ethiopia, the
Ministry of Finance and Economic Cooperation (MoFEC), the Central Statistics Authority (CSA), the

ev
International Monetary Fund (IMF), World Bank Statistics, and other relevant reports. Furthermore,
mathematical computations are performed to obtain the data in the required format, and we used a

r
natural logarithm to handle outlier problems.

3.1.1. Data and variables

er
For the usual reason, availability of data, this paper covers the period from 1991- 2020, while the
variables incorporated in the study are chosen with consideration for both economic theory and
pe
empirical research on the subject (Rodrick, D., 2008; Semuel, H., & Nurina, S., 2014; Barro, R. J.,2013).
The variables under consideration in the study are as follows. Inflation is the endogenous variable in a
tri-variant setup, and it is measured using the consumer price index (percent). The data is retrieved from
the IMF financial data set and expected to have negative relationship with economic growth and
ot

positively related with exchange rate. Exchange rate: is the other main endogenous variable
incorporated in this study, and we expect to have positive effect on inflation (increases) and economic
tn

growth. The data is extracted from World Bank development indicator and more precisely we use the
effective exchange rate.

Economic growth (GDP per capita): is one of the endogenous variables examined in this paper, and it is
rin

measured by real GDP per capita, which is expressed in constant international dollars per person and
calculated by dividing GDP by population at constant prices. In this paper, real GDP per capita is
expected to have a positive impact on inflation while having a negative impact on the exchange rate.
ep

The data is retrieved from World Bank development indicator. Broad money (MB) is used as a proxy for
broad money supply, and data is obtained from the World Bank database. The inflation model considers
this variable to be an explanatory variable. Financial sector development; there are many financial
Pr

sector development proxies, while in this paper; we used bank deposit (% of GDP) for consistency

This preprint research paper has not been peer reviewed. Electronic copy available at: https://ssrn.com/abstract=4473206
 purposes with theoretical arguments of money supply. Regulatory Quality measures public perceptions

ed
of the government's ability to develop and implement sound policies [-2.5, 2.5]. Investment spending (%
GDP): expressed as ratio of total investment in current local currency and GDP in current local currency.
Investment spending is expected to have positive impact on economic growth.

iew
Tax (%GDP): Tax revenue refers to compulsory transfers to the central government for public purposes.
This is the revenue that the country collects internally and expected to have positive impact on
economic growth. Trade openness (total trade % of GDP) is a measure of countries degree of openness.
Though there are many measures of trade openness the ratio of its export and import to GDP is the

ev
common and best measure of trade intensity or openness. Current account balance (%GDP): current
account is the balance of payment excluding the capital account. Current account deficit occurs when
the difference between revenues and costs from trade plus net transfers to the country is negative.

r
Finally, in table (1), this paper presented all variables included in this study, along with their mnemonic,
measurement, and data source.

Table (1): Variables involved in the study

er
pe
Variables Mnemonic Measurement Source

Inflation INF (%) CPI IMF financial statistics

ot

Tax (%GDP): TAX % of GDP WB, development indicator

Broad money MB % of GDP WB, development indicator

tn

Financial sector FSD % of GDP WB, development indicator

development

Trade openness TOP % of GDP WB, development indicator

rin

Investment (%GDP) INV % of GDP WB, development indicator

Effective exchange rate EXR (%) percentage WB, development indicator

GDP per capita Gdppercapita In dollars ($) WB, development indicator

ep

Regulatory quality RegQ Index [-2.5,2.5] WB, governance indicator

Source: Authors (2022)

Pr

This preprint research paper has not been peer reviewed. Electronic copy available at: https://ssrn.com/abstract=4473206
 3.1.2. Econometric model specification

ed
In this study the relationship of variables such as inflation, exchange rate, and real GDP are estimated
using time series analysis. Existing research indicates that the causal flow in the exchange rate, inflation,

iew
and economic growth can change (see, Fitsum, et al., 2016; Girma, 2012; Ogbuabor, et al., 2020;
Getachew, 2018). Therefore, estimation in which one series is supposed to be dependent while the
others are independent may be questionable. As a result, we specified a model in which each series'
exogeneity is not pre-assumed. The three variables of interest are endogenous, meaning they can
appear on both the left and right sides of the equations. Other explanatory variables are also included as

ev
controlled variables in each model or equation. The equation for an endogenous variable inflation is
given by,

r
𝐼𝑛𝑓𝑙𝑎𝑡𝑖𝑜𝑛 = 𝛽0 + 𝛽1𝐷𝐸𝐸𝑅 + 𝛽2𝐷𝐺𝐷𝑃 + 𝛽3𝐷𝑀2 + 𝛽4𝐷𝑇𝑂𝑃 + 𝛽5𝐷𝐹𝐷 + 𝜀, ― ― ― ― ― ― ― ― ― ― ― ― ― ―(1)

er
Where 𝐼𝑛𝑓𝑙𝑎𝑡𝑖𝑜𝑛 is inflation measured in CPI, 𝐷𝐸𝐸𝑅 is exchange rate, 𝐷𝐺𝐷𝑃 is gross domestic product
per capita, 𝐷𝑀2 is broad money, 𝐷𝐹𝐷 is financial sector development,𝑇𝑂𝑃 trade openness, and 𝜀 is the
pe
error term. These variables are used in studying the determinants of inflation in Ethiopia. Next, we
introduced an equation for the endogenous variable, exchange rate. There are two main theory of
exchange rate determination: flow and stock theory of exchange rate determination. But here we
include all the explanatory variables in a single equation, which is
ot

𝐷𝐸𝐸𝑅 = 𝛼0 + 𝛼1𝐼𝑛𝑓𝑙𝑎𝑡𝑖𝑜𝑛 + 𝛼2𝐷𝐺𝐷𝑃 + 𝛼3𝐷𝑇𝑂𝑃 + 𝛼4𝐷𝑇𝐴𝑋 + 𝛼5𝐷𝐹𝐷𝐸𝑉𝑇 + 𝜀, ― ― ― ― ― ― ― ― ― ― ― (2)

tn

Where 𝐷𝐸𝐸𝑅 is exchange rate, 𝐼𝑛𝑓𝑙𝑎𝑡𝑖𝑜𝑛 is inflation measured in CPI, 𝐷𝐺𝐷𝑃 is gross domestic product
per capita, 𝐷𝑇𝑂𝑃 is trade openness, 𝐷𝐹𝐷𝐸𝑉𝑇 is financial sector development, 𝐷𝑇𝐴𝑋 is internal
revenue from tax, and 𝜀 is the error term. The third equation to be estimated is an equation for the real
rin

gross domestic product, which is given by

𝐷𝐺𝐷𝑃 = 𝛾0 + 𝛾1𝐼𝑛𝑓𝑙𝑎𝑡𝑖𝑜𝑛 + 𝛾2𝐷𝐸𝐸𝑅 + 𝛾3𝑟𝑒𝑔𝑞 + 𝛾4𝐷𝐼𝑁𝑉 + 𝛾5𝐷𝑇𝑂𝑃 + 𝛾6𝐷𝐹𝐷 + 𝜀, ― ― ― ― ― ― ― ― ― (3)

Where 𝐷𝐺𝐷𝑃 is real gross domestic product, 𝐼𝑛𝑓𝑙𝑎𝑡𝑖𝑜𝑛 is inflation measured in CPI, 𝐷𝐸𝐸𝑅 is effective
ep

exchange rate, 𝑟𝑒𝑔𝑞 is regulatory quality, 𝐷𝐼𝑁𝑉 is investment spending, 𝐷𝑇𝑂𝑃 is trade openness, 𝐷𝐹𝐷
is financial development proxy and 𝜀 is the error term.
In order to examine the short run relationships the error correction model (ECM) is derived, and the
Pr

ARDL (p,q) time series models are estimated. With parameterization and explicitly incorporating the

This preprint research paper has not been peer reviewed. Electronic copy available at: https://ssrn.com/abstract=4473206
 main interest variables as a vector the ARDL (p,q) model that relates exchange rate, inflation economic

ed
growth, equation (1,2&3) is transformed to the error correction model (ECM) that takes a form:

∆𝑦𝑖 = ∅(𝛽0 + 𝛽1𝑦𝑡―𝑗 + 𝛽2𝑥𝑡―𝑗) + ∑𝑝―1

𝑖=1 𝜗1𝑦𝑡―1
+ ∑𝑞―1
𝑖=1 𝜗2𝑥𝑡―1
+ 𝑢𝑡— ― ― ― ― ― ― ― ―(4)

iew
Where: 𝑦𝑖 denotes the vector of endogenous variables such as inflation, economic growth and exchange
rate, 𝑥𝑖 denotes a vector of control variables such as broad money, credit provided for private sector,
bank deposit percentage of GDP, trade openness, investment spending, regulatory quality, and revenue

ev
from tax, ∅𝑖 denotes the speed of adjustment, 𝛽𝑠 denote long-run coefficients, and 𝜗𝑠𝑖 are short-run
coefficients. Whereas 𝑡 represent time. In this analysis we use trend as a variable to capture the other
variables not included in the model.

r
One of the great contributions in the ARDL model by Pesaran et al. (2001) is that the Bound test of Co-
integration with the null hypothesis of no co-integration, using the error correction representation of

er
the ARDL process. And that is testing whether ∅ in equation (4) is zero or not. Hence, the long run and
short run estimates are depicted after approval of the ARDL Bound test of co-integration, and the
pe
Granger causality results are obtained from vector autoregressive model. However, Granger causality
test results are highly sensitive to the lags incorporated in the model. Hence, the optimal lag length is
determined through the information criterion. At last, the ARDL model has a number of desirable
properties. First, the ARDL model provides consistent estimates of both short-run and long-run and valid
ot

t-tests. Second, the ARDL model is suitable when variables are a mix of I (0) and I (1) and third, ARDL
helps to mitigate the Endogeneity problem that arises from the omission of significant variables.
tn

3.2. Estimation procedures

We employed a times series models that able to take into consideration and solve issues related to
rin

endogeneity. In particular, by using ARDL, VAR and VECM methodology, all variables are estimated
endogenously and these models also allow us to detect and estimate causality between exchange rate,
inflation, and economic growth. However, as requirement, in order to arrange the data accurately and
ep

have correct inference, we implement the following steps. First, the optimal lag length of our models is
determined through the information Criteria (AIC, BIC, and SBC) with the help of the vector
autoregressive model (VAR).
Pr

Second, we investigate the stochastic properties of the time series involved in the study. Hence, a
standard unit root test is conducted on selected series to capture the order of the integration and then

This preprint research paper has not been peer reviewed. Electronic copy available at: https://ssrn.com/abstract=4473206
 the model. A time series is stationary if its mean and variance do not vary systematically with time. If its

ed
mean and variance vary systematically with time, the variable is non stationary. There by regressing non
stationary (not co integrated) variables leads spurious regression (Gujarati, 2003). So, to have better
results and correct statistical inferences the leading property of time series variables stationarity is

iew
checked using Phillips Perron unit root test.
More specifically, the Phillips and Perron (1988) test is implemented since it is more powerful than the
augmented Dickey-Fuller test (Davidson and MacKinnon, 1993). On the top of that, the Phillips Perron
unit root test has these two advantages over augmented Dickey-Fuller test (ADF). One, the Phillips and

ev
Perron (1988) test allows autocorrelation in residuals. Second, the user does not have to specify a lag
length for the test regression. Albeit for purpose of sensitivity check, we also used the augmented
Dickey-Fuller test (ADF). The test regression for Phillips and Perron (1988) unit root test is given by:

r
∆Yt = βDt + πYt―1 + εt ― ― ― ― ― ― ― ― ― ― ― ― ― ―(5)

er
Where εt the error term is ~ I (0) and ∆ indicates the first difference operator. Based on the Phillips and
Perron (1988) unit root test, the null hypothesis is that the series contains a unit root, and the
pe
alternative is that the variable was generated by a stationary process. Third, if the variables are a mix of
I(0) and I(1), ARDL Bound test is carried out for long run relationships. In addition, the ARDL econometric
techniques allow us to estimate short- and long-run causality between the variables of interest
(inflation, exchange rate, and economic growth. Fourth, the Toda Yamamato Granger causality tests are
ot

carried out to solve the issue of granger causality. This Bound test of co-integration has several
advantages over the Engle Granger and Johansson co -integration test. One, we can have a co-
tn

integration even if variables are stationary at different order i.e. I (1) and I (0) but not I (2). Two, we can
attach different lags for each variable under examination in the ARDL environment. Three, long run
estimates based on ARDL model are supper consistent in small sample size. At last, the fully modified
rin

ordinary least square (FMOLS) method of Phillips and Hansen (1990) is estimated to check sensitiveness
of our results to different models and different specifications. Using the fully modified ordinary least
square (FMOLS) rather than ordinary OLS helps to correct the standard OLS bias induced by the
Endogeneity and serial correlation of the regressors, and allows for the presence of mix of I (0) and I (1)
ep

variables in the co integrated system and the technique performs well in finite samples, respectively
(H.Stock & W.Watson, 1993).
Pr

This preprint research paper has not been peer reviewed. Electronic copy available at: https://ssrn.com/abstract=4473206
 4. Discussion

ed
4.1. Descriptive Analysis

In quantitative analysis, descriptive statistics are presented before inferential statistics. Descriptive

iew
statistics provide an overall view of the data regarding the trend of target variables, measures of the
central tendency, and dispersion and association measures of the variables in the data set. The following
figures examine the movement and behavior of the data series over time for the target variables, such
as economic growth, inflation, and exchange rate. Figure 1 (below) highlights the trend of GDP per
capita as a measure of economic growth from 1991 to 2020. GDP per capita was $578 in 1991; by 2000,

ev
it had risen to $653; and by 2020, it would have reached $2073. From the figure, we noted a persistent
increase in GDP per capita in all the years under review except for a period between 1998 and 2003. This

r
simply shows that GDP per capita is increasing from one year to the next unless there is a political
regime shift and instability in the country.

er
2000

pe
1500
GDP per capita
1000 500

ot

1990 2000 2010 2020

Year

Figure (1): trend of GDP per capita. Source: Author’s computation (2022)
tn
250
40 30

Effective exchange rate

200
inflation rate_ CPI
20

rin

150
10 0

100
-10

1990 2000 2010 2020 1990 2000 2010 2020

Year Year
ep

Figure (2): trend of inflation. Figure (3): trend of exchange rate

Source: Author’s computation (2022)

Pr

This preprint research paper has not been peer reviewed. Electronic copy available at: https://ssrn.com/abstract=4473206
 However, the question is what the purchasing power of these incomes is in different periods: is the

ed
increase in GDP per capita only associated with an increase in price levels or does it affects the people's
living standards? Figure (2) also highlighted the inflation rate measured by the consumer price index for
the sample period from 1991 to 2020. From the figures, the inflation rate (CPI) has shown some

iew
fluctuations over the sample period. On the one hand, the inflation rate recorded 35% in 1991 and
declined to -8.2% in 2001. On the other hand, statistics for 2011 show a higher inflation rate, which is
35%, and again, it decreases to 20.4% in 2020. Different factors can contribute to these fluctuations.
Looking at the past economic histories in line with the top and bottom points, the following factors are

ev
expected to be the cause of the variations: For example, the statistics of the years 2008 and 2011 are
among the pick points, and as per the IMF's (2008) report, the problem was a demand and supply
imbalance, leading to demand-pull inflation. The country is producing poorly compared to what the

r
country demands, which is reflected in higher prices for food items and oil price hikes. The lower
inflation level is registered for the period 1996–2001, and this period in Ethiopia is known for political

er
turmoil and the first and second phases of privatization. Accordingly, what we expect is a higher
inflation rate, but practically, it was the opposite. However, this might indicate that common pool
pe
resources are redistributed, which would cause the price to go down.
Finally, the trend of the third target variable, the exchange rate, is presented in Figure 3. From the
figure, we observe that the effective exchange rate is continually decreasing from 1991 up to 2004,
whereas from 2005 onwards the effective exchange rate is monotonic enough. This can also be related
ot

to country politics, the general election of 2005, and external forces. Due to the diaspora community's
opposition to the incumbent party following the election, the amount of remittances that the nation
tn

receives decreased. In addition to the remittances from the diaspora, the country also loses aid and debt
to other countries, which affects the foreign exchange market. As part of the descriptive analysis, table
(2) displayed descriptive statistics for each of the variables involved in the study. Looking at the target
rin

variables, the mean, maximum, and minimum values of GDP per capita (a proxy for economic growth)
are $972, 2073, and 509, respectively. More precisely, the minimum statistics registered are associated
with the first decade of the study, whereas the maximum values registered are associated with the
ep

recent period of the study. From the table, we also observed that inflation reaches a maximum of 44.3%,
a minimum of -8.5%, and a mean value of 11%, respectively. IMF's (2008) staff report indicates that the
maximum inflation for the period 2007–08 is due to higher demand or a shortage of production.
Pr

This preprint research paper has not been peer reviewed. Electronic copy available at: https://ssrn.com/abstract=4473206
 ed
Table (2) Descriptive Statistics
Variable Obs Mean Std. Dev. Min Max
GDP 28 972.126 477.003 509.216 2073.05

iew
Inflation 30 11.181 11.527 -8.484 44.391
EER 28 128.534 36.955 91.343 231.558
Top 28 44.454 15.025 12.889 68.19
Inv 28 24.126 9.341 10.594 39.417
M2 30 33.115 6.068 24.805 45.353

ev
Tax 29 9.977 2.116 5.23 12.734
Fdevt 18 13.593 6.526 1.474 20.449
Regq 30 -1.042 .096 -1.297 -.86

r
FD 28 23.492 5.798 13.771 34.644
Source: Authors estimation result (2022)

er
Mainly, the higher inflation is a result of rapidly rising food prices. In addition, the rising global prices are
also important factors, especially the oil price, which strains Ethiopian balance of payment. Finally,
statistics for 2019 and 2020 show a higher figure, which is two times the mean value inflation level, and
pe
this can be due to the political instability that has existed since 2017. Finally, effective exchange rate
statistics during the study period show that the mean value, the minimum, and the maximum are
128.5%, 91.3%, and 231%, respectively.
ot

Correlation quantifies the strength of the linear relationship between two variables and also indicates
the direction of the association. Table 3 (below) shows the pairwise correlations between variables.
tn

From the table, we observe that the correlation among the target variables, such as economic growth,
inflation, and exchange rate (the mnemonic in the table is DGDP, Inflation, and DEER, respectively), is
significant and positive. This seems to suggest that a higher effective exchange rate is related to higher
rin

inflation and higher economic growth. However, correlation does not necessarily mean causation.
Additionally, the exogenous variables like regulatory quality and investment spending are also positively
correlated with the proxy for economic growth, GDP per capita. The institutional variable, regulatory
quality, and investment go hand in hand, and they are positively related to production or GDP. While
ep

control variables like trade openness and deposit percent of GDP are negatively correlated with the
proxy for economic growth, GDP per capita, This seems also intuitive because, compared with its trading
partners, Ethiopia lacks infrastructural development, skilled manpower, and stable politics, so she
Pr

becomes a net importer, which can affect economic growth negatively. In the same vein, the higher the

This preprint research paper has not been peer reviewed. Electronic copy available at: https://ssrn.com/abstract=4473206
 currency is deposited in a bank, the more it might repress investment and further production due to the

ed
collateral problems, access, and efficiency of the financial sectors in the country.

Table (3): Matrix of correlations

iew
Variables (1) (2) (3) (4) (5) (6) (7) (8) (9) (10)
(1) DGDP 1.000
(2) Inflation 0.202 1.000
(3) DEER 0.262 0.385 1.000
(4) DTOP -0.268 -0.618 -0.516 1.000

ev
(5) DINV 0.237 -0.376 -0.287 0.067 1.000
(6) DM2 -0.613 -0.484 -0.019 0.249 -0.112 1.000
(7) DTAX 0.130 -0.510 -0.095 0.459 0.342 0.325 1.000

r
(8) DFDEVT -0.086 -0.339 -0.154 0.208 -0.093 0.107 0.066 1.000
(9) DFD -0.681 -0.317 0.131 0.264 -0.177 0.709 0.357 0.233 1.000
(10) regq 0.331 0.644 0.086
er
-0.250 -0.253 -0.380 -0.167 -0.424 -0.452 1.000
pe
Source: Authors estimation result (2022)
Considering the inflation model, exogenous variables such as trade openness, broad money, and
currency deposited in banks are negatively correlated. The correlation between broad money and
inflation is against the mainstream economic theory. According to Friedman (1969), inflation is directly
associated with an increase in the money supply. Referring to the negative correlation between trade
ot

openness and inflation is theoretically consistent because, in addition to domestically produced goods,
county residents can get those products produced abroad, and the completion itself reduces the price of
tn

goods. Finally, according to Greene (2003), Gujarati (2004), and Wooldridge (2001), Multicollinearity
among independent variables is not a big issue. However, it can lead to less precise coefficient
estimates, and thus low Multicollinearity is generally acceptable. Accordingly, we look at the
rin

magnitudes, and there is no higher figure to suspect the Multicollinearity problem since the maximum
value we detected is 0.7 (between the deposit percent of GDP and broad money).
ep
Pr

This preprint research paper has not been peer reviewed. Electronic copy available at: https://ssrn.com/abstract=4473206
 4.2. Econometric analysis

ed
4.2.1. Unit root test results

As a preliminary step, to ascertain the order of integration of the variables incorporated in the study, two unit root
tests are employed. Specifically, the Philipis-Perron (1981) unit-root test and the Augmented Dickey-Fuller unit-root

iew
test are performed. In both tests, the null hypothesis entails that variables are non-stationary, and the alternative is
that the variables are stationary. However, our analysis mainly relies on the results of the Philipis-Perron (1981)
unit-root test for the reasons stated in the methodology part.

Table (4): unit root test

ev
(A) (B) (C) (D)

Variables PP unit-root test PP unit-root ADF unit-root ADF unit-root test

r
statistics statistics statistics statistics

GDP per capita

Trade openness

Investment
0.468

-1.983

-0.423
er
-4.597***

-3.962***

-7.175***
2.167

-1.724

-0.021
-2.643*

-2.868 **

-2.660 *
pe
Broad money -1.746 -4.627*** -1.983 -4.559***

Tax -1.639 -3.502*** -2.314 -3.325 **

Credit -2.133 -3.387** -2.512 - -2.500 **

ot

Deposit -1.503 -3.108** -2.390 -3.146**

Inflation -4.369 *** -4.317*** -16.7112***

tn

Exchange rate -3.152 ** -1.366 --3.294**

Regulatory -3.464*** -1.779 -3.383**

*** p<0.01, ** p<0.05, * p<0.1

Source: Authors estimation result (2022)
rin

NB: Where column (A, B, C, and D) indicates the Philipis- perron (1981) unit-root test and Augmented Dickey-
Fuller unit-root test for level and first difference, respectively.

Before unit root tests are carried out, as an initial step in the analysis, the optimal lag length for both the
ep

stationarity tests and the ARDL model is determined via the pre-and post-Varisoc results of the

information criteria. Results on optimal lag length determination are presented in the appendix. From
Pr

the table, we noted that all the variables are not stationary at level except the endogenous variables

This preprint research paper has not been peer reviewed. Electronic copy available at: https://ssrn.com/abstract=4473206
 inflation and effective exchange rate and the exogenous variable regulatory quality, which are stationary

ed
at level 0 (zero). When you find a mixed result of the order of integration in the unit root test, such as

I(0) and I(1), the autoregressive distributed lag method is the appropriate model in a time series

iew
analysis. (Ajala and Babatunde, 2009; Lean and Smyth, 2009; Omisakin, 2009). As a rule of thumb, for

robust ARDL estimates, I (0) and I (1) stationary variables are required, not I (2). Hence, the first

differences are also computed and checked for stationarity, and all the variables are converted to

ev
stationary. On top of that, we tested the unit root tests with different options (with drift and trend) in

both methods, and we found that the results were not sensitive.

r
4.2.2. ARDL Bound test of co-integration

On determination of the presence of unit roots (non-stationarity) in the variables, the study proceeds to

er
the co-integration tests. The purpose of the Co-integration test is to determine whether a group of non-
stationary series is Co-integrated or not.
pe
Table (5): Pesaran/Shin/Smith (2001) ARDL Bounds Test. H0: no levels relationship
Critical Values (0.1-0.01), F-statistic, Case 5
[I_0] [I_1] [I_0] [I_1] [I_0] [I_1] [I_0] [I_1]
ot

L_1 L_1 L_05 L_05 L_025 L_025 L_01 L_01

tn

Growth 4.190 5.060 4.870 5.850 5.490 6.590 6.340 7.520

Inflation 4.190 5.060 4.870 5.850 5.490 6.590 6.340 7.520
Exchange 4.190 5.060 4.870 5.850 5.490 6.590 6.340 7.520
Growth Inflation Exchange
F = 21.540 F = 6.859 F = 6.329
rin

Accept if F < critical value for I(0) regressors. Reject if F > critical value for I(1) regressors
Source: Authors estimation result (2022)
ep

The presence of a co-integrating relation forms the basis for short- and long-run dynamics in the ARDL
model. From the bound co-integration test results presented in Table 5 below, the null hypothesis of no
co-integration is rejected when comparing the F statistics with the critical values. Rejecting the null
Pr

hypothesis of no co-integration between the I (zero) and I (one) series implies that there is a long-run
relationship between the variables; the variables move together in the long run.

This preprint research paper has not been peer reviewed. Electronic copy available at: https://ssrn.com/abstract=4473206
 4.2.3. Short run and long relationships

ed
As we observed, our targeted variables - GDP per capita, inflation, and exchange rate - exhibit a long-run
relationship with one another. Therefore, the error correction models are estimated in order to
investigate the short- and long-run dynamics. The results are shown in Table 6. According to estimation

iew
findings, inflation and the exchange rate both have a long-term, significant negative impact on Ethiopia's
economic growth.

Table (6): Short run and long run dynamics

ev
Variables Growth Inflation Exchange

ECT (∅) -0.906522*** -0.941857*** -0.6300186 **

Long run estimates

r
DGDP -0.3070843* -0.785223 *

Inflation

DEER
-2.336351*

-1.25238**
er -0.4181212
2.995776*
pe
Short run estimates

DGDP | LD. -.1259881 .1543315** 0.0543926*

DGDP |L2D. -.2124085*

DGDP |D1. 1543315** .1305363**

ot

Inflation |D1. 0.6224485 -1.953569*

Inflation |LD. -2.083863*** -.6261023** -1.100387

tn

DEER |D1. 1.092014** .5023026***

DERR |LD. 1.295209*** .2664429**

DTOP -2.855197 -.8909906** -1.509621**

rin

Regq 123.676*

DINV 5.238298***

DFD -11.44785*** 0.2408568

ep

DM2 -2.561378**

DTAX 1.124854

DFDEVT 1.929584**
Pr

Year 5.316838*** 2.499205*** 1.530272 **

This preprint research paper has not been peer reviewed. Electronic copy available at: https://ssrn.com/abstract=4473206
 -cons -10458.27*** -4986.962*** -3056.45 **

ed
legend: * p<.05; ** p<.01; *** p<.001

Source: Author’s computation (2022).

iew
Specifically, a 1% increase in the exchange rate and the inflation rate is associated with an increase in

economic growth of about 0.89 and 1.57, respectively. Apart from that, the long-run causality is

detected through the error correction term; in all the models, it is negative, below one, and significant,

ev
and this confirms the existence of long-run causality. As seen in Table (6), the long-run causality runs

from inflation and exchange rate to economic growth since the error correction term in column (3) is

negative and also statistically significant. In addition, the coefficient is less than unitary (1),

r
approximately -0.0055, and significant at the 99% confidence level. Hence, we reject the null hypothesis,

er
maintaining that the parameter is different from zero, and conclude that a statistically significant long-

run causality running from inflation and exchange rate to economic growth exists.
pe
In the same vein, the error correction term of the inflation and exchange rate models confirms the long-

run causality as it is bi-directional. While the short-run causality is estimated through the Wald test,
ot

which also allows us to estimate the transmission channels, the Wald test is presented in Table 6.

However, the effect of the exchange rate and inflation rate changes to positive in the short run. More
tn

specifically, a 1% change in the exchange rate and inflation is associated with 0.93 and 0.48 percent

increases in economic growth in the short run; other things remain constant. In addition to that, the
rin

exogenous covariates such as trade openness, investment spending, and financial depth are significant

variables in the growth model. The diagnostic tests such as Multicollinearity, the ARCH test, the

normality test of the residual term, white Heteroscedasticity, and the Ramsey RESET model specification
ep

test are reported in the tables presented in the appendix. The evidence indicates no Multicollinearity,

the residual term is normally distributed, and the model is well specified. There is no evidence of
Pr

This preprint research paper has not been peer reviewed. Electronic copy available at: https://ssrn.com/abstract=4473206
 autoregressive conditional Heteroskedasticity, and the same inference can be drawn for white

ed
Heteroskedasticity.

4.2.4. Granger causality test results

iew
Table (7): Short run Granger causality Wald test results

Equation Excluded chi2 Df Prob>Chi2

DGDP Inflation 18.290 2 0.000

ev
DGDP DEER 0.950 2 0.622

DGDP ALL 20.336 4 0.000

r
Inflation DGDP 4.077 2 0.130

Inflation DEER 4.940 2 0.085

Inflation ALL 6.361

er 4 0.174
pe
DEER Inflation 2.009 2 0.366

DEER DGDP 3.772 2 0.152

DEER ALL 8.297 4 0.081

Source: Authors estimation result (2022)
Table 7 presents the results of the Granger causality tests; the null hypothesis asserts that no Granger
ot

causality runs from inflation to economic growth and vice versa. According to Table 7, the results reject
tn

the null hypothesis of no Granger causality running from inflation to economic growth. In addition,

significant causation is detected from the exchange rate to inflation. This shows the importance of

inflation to economic growth, even though economic growth is not a cause of inflation in the short run.
rin

Again, evidence shows the importance of the exchange rate to inflation and how inflation also induces

more pressure in the exchange rate market.

ep
Pr

This preprint research paper has not been peer reviewed. Electronic copy available at: https://ssrn.com/abstract=4473206
 4.2.5 Sensitivity of results

ed
As a means of checking the robustness of the long-run ARDL model results, the data is submitted to a
sensitivity test, which is done through the fully modified least square (FMOLS) estimation method.
Accordingly, the results presented in Table 8 indicate that the findings are consistent in terms of sign,

iew
magnitude, and level of significance with the main ARDL model results displayed in Table 6. That means
the size of the coefficients is almost the same, and the signs of the coefficients are as expected and
statistically significant for different estimators.

ev
Table (8): Results of FMOLS growth model

Dependent Variable: GDP Method

Additional regressors: TOP INV REGQ FD

r
Long-run covariance estimate (Bartlett kernel, Newey-West fixed bandwidth
= 3.0000)

Variable
er
Coefficient Std. Error t-Statistic Prob.
pe
INFLATION -9.153280 2.965156 -3.086948 0.0052
EER 3.396548 1.070655 3.172401 0.0042
C -152.8821 121.7885 -1.255308 0.2220
@TREND 57.52158 4.440518 12.95380 0.0000
ot

R-squared 0.906460 Mean dependent var 986.7097

Adjusted R-squared 0.894259 S.D. dependent var 479.6861
tn

S.E. of regression 155.9837 Sum squared resid 559610.7

Long-run variance 23223.95

Source: Authors estimation result (2022)

rin

The only difference captured in the sensitivity check estimation through the FMOLS technique is that the
sign of the exchange rate changed to positive, and the constant is insignificant; however, the sign of the
coefficient for the other variables is still the same. In addition, the results of the inflation model
ep

presented in Table 9 are also consistent with the ARDL model. That means the variables such as GDP per
capita, the trend, and the constant are significant and have the same sign. However, the exchange rate
is insignificant in the ARDL estimation technique, whereas in the FMOLS estimation, it is significant at a
Pr

95% confidence level.

This preprint research paper has not been peer reviewed. Electronic copy available at: https://ssrn.com/abstract=4473206
 Table (9): Fully Modified Least Squares (FMOLS) results of the inflation model

ed
Dependent Variable: INFLATION
Additional regressors: TOP M2 FD

Variable Coefficient Std. Error t-Statistic Prob.

iew
GDP -0.032400 0.013125 -2.468616 0.0214
EER 0.197421 0.087741 2.250033 0.0343
C -10.41153 8.407480 -1.238365 0.2281
@TREND 1.965553 0.693481 2.834327 0.0094

ev
R-squared 0.263449 Mean dependent var 9.758409
Adjusted R-squared 0.167377 S.D. dependent var 10.90066
S.E. of regression 9.946660 Sum squared resid 2275.529

r
Long-run variance 101.1097
Source: Authors estimation result (2022)
Finally, the results of the exchange rate model presented in Table 10 also indicate that our main
er
estimation technique, the ARDL, is robust. The only difference we noted in this model is that both GDP
per capita and inflation are significant in the main model, while with the FMOLS estimation technique,
pe
GDP per capita turns insignificant. Still, the magnitudes and signs of the coefficients are consistent with
the ARDL estimation method, and we conclude that our main model is non-sensitive to changes in
estimation techniques.
Table (10): Fully Modified Least Squares (FMOLS) results of exchange rate model
ot

Dependent Variable: EER

Additional regressors: TOP TAX FDEVT
tn

Variable Coefficient Std. Error t-Statistic Prob.

INFLATION 2.089161 0.566775 3.686053 0.0027

rin

GDP 0.018089 0.107321 0.168554 0.8687

C 120.7909 53.28179 2.267021 0.0411
@TREND -4.324890 2.299929 -1.880445 0.0826
ep

R-squared 0.432745 Mean dependent var 110.7234

Adjusted R-squared 0.301840 S.D. dependent var 25.29683
S.E. of regression 21.13702 Sum squared resid 5808.056
Long-run variance 449.0238
Pr

Source: Authors estimation result (2022)

This preprint research paper has not been peer reviewed. Electronic copy available at: https://ssrn.com/abstract=4473206
 5. Conclusion and Policy Implications

ed
Most of the growth models place emphasis on real macroeconomic variables, and they try to justify that

the monetary aspect of the economy does not influence real variables; money is neutral. However, this

iew
paper focuses on the counterfactual: what if the money is not neutral? The interest emanated from the

real problems that Ethiopia has faced for the last decade. For the last decade, the inflation rate has

increased at an alarming rate (it was 11% in 2014 and 35% in 2022), the national bank has embarked on

ev
continuous devaluation of the Ethiopian birr, and economic growth rates have declined.

Macroeconomic stability is the major concern of each country in the world. For that matter,

r
independent central banks have single-objective price stability. If they are not, the government or the

incumbent party forces the bank to contain other objectives such as economic development, the
er
eradication of poverty, and employment generation. Accordingly, if the policymakers thought that the
pe
general price was too high, they would make policy changes. However, the problem for policymakers is

the policy mix; the policy intervention in fighting inflation has a consequence on the other

macroeconomic variables of economic growth and employment.

ot

On top of that, the Ethiopian economy is characterized by budget deficits, which result from either

lower production or the residents' proclivity for imports. Hence, this higher demand for foreign goods
tn

influences the exchange market and rounds up to the goods market. This paper, therefore, contributes

to the existing literature by analyzing the interlinkage of the exchange rate, inflation, and economic
rin

growth concerning the Ethiopian macroeconomic environment for the period 1991–2020. The study

uses the ARDL model for short-run and long-run dynamics, the bound test of the co-integration, and the

Granger causality tests to detect if past values affect the current values.
ep

At last, exogenous variables such as trade openness, investment spending, broad money, financial

sector development measures, internal tax revenue, and regulatory quality are incorporated in the
Pr

study. The ARDL model estimates suggested that inflation and exchange rate are negatively related to

This preprint research paper has not been peer reviewed. Electronic copy available at: https://ssrn.com/abstract=4473206
 economic growth. This implies that an increase in the price level will decrease the production of goods

ed
and services, and devaluation also has a deteriorating impact. Thus, strengthening domestic resource

mobilization, improving regulatory quality, and enhancing financial sector depth can be considered as

iew
the way out of this chronic foreign exchange shortage, higher inflation, and lower economic growth

rates.

r ev
er
pe
ot
tn
rin
ep
Pr

This preprint research paper has not been peer reviewed. Electronic copy available at: https://ssrn.com/abstract=4473206
 6. References

ed
1. Ahortor, C. R., & Adenutsi, D. E. (2009). Inflation, capital accumulation and economic growth in
import-dependent developing countries.
2. Ayyoub, M., Chaudhry, I. S., & Farooq, F. (2011). Does Inflation Affect Economic Growth? The

iew
case of Pakistan. Pakistan Journal of Social Sciences (PJSS), 31(1).
3. Barro, R. J. (2013). Democracy, law and order, and economic growth. 2013 Index of Economic
Freedom, 41-58
4. Dornbusch, R., S. Fischer and C. Kearney. (1996). Macroeconomics. The Mc-Graw-Hill
Companies, Inc., Sydney.
5. Durevall, D., & Sjö, B. (2012). The dynamics of inflation in Ethiopia and Kenya. African

ev
Development Bank Group
6. Ebiringa, O. T., & Anyaogu, N. B. (2014). Exchange rate, inflation and interest rates relationships:
An autoregressive distributed lag analysis. Journal of Economics and Development Studies, 2(2),

r
263-279.
7. Fischer, S., (1983). Inflation and Growth‟, NBER Working Paper 1235, Cambridge: National Bureau of
Economic Research.

er
8. Fitsum, S., Yilkal, W. and Teshome, A. (2016). “The Relationship between Inflation, Money Supply and
Economic Growth in Ethiopia: Co-integration and Causality Analysis”, International Journal of Scientific
and Research Publications, 6(1).
pe
9. Friedman, M., & Schwartz, A. J. (1969). The definition of money: net wealth and neutrality as
criteria. Journal of Money, Credit and Banking, 1(1), 1-14
10. Gebregziabher, F. H. (2019). The exchange rate: Why it matters for structural transformation
and growth in Ethiopia. World Bank Policy Research Working Paper, (8868).
11. Getachew, A., & Meaza, C. (2018). Do prices influence economic growth? Estimating the
ot

inflation threshold of the Ethiopian economy. Journal of Economics and Sustainable

Development, 9(1), 46-56.
12. Girma, F. D. (2012). Relationship between inflation and economic growth in Ethiopia: An
tn

empirical analysis, 1980-2011 (Master's thesis).

13. Gokal, V., & Hanif, S. (2004). Relationship between inflation and economic growth (Vol. 4). Suva:
Economics Department, Reserve Bank of Fiji
14. Ijaz, U. (2021). Impact of inflation on economic growth in Pakistan. Economic Consultant, (2
rin

(34)), 33-41.
15. Johnson, H. G. (1967). Is inflation a retarding factor in economic growth. Fiscal and Monetary
Problems in Developing States, 121-37
16. Kayamo, S. E. (2021). Asymmetric impact of real exchange rate on inflation in Ethiopia: a non-
ep

linear ARDL approach. Cogent Economics & Finance, 9(1), 1986931

17. Khan, M. S., & Ssnhadji, A. S. (2001). Threshold effects in the relationship between inflation and
growth. IMF Staff papers, 48(1), 1-21.
18. Khan, R. E. A., Sattar, R., & Rehman, H. (2012). Effectiveness of exchange rate in Pakistan:
Pr

Causality analysis. Pak. J. Commer. Soc. Sci, 6(1), 83-96.

This preprint research paper has not been peer reviewed. Electronic copy available at: https://ssrn.com/abstract=4473206
 19. Kibria, U., Arshad, M. U., Kamran, M., Mehmood, Y., Imdad, S., & Sajid, M. (2014). Exploring the

ed
Impact of Macro Economic Variables on GDP Growth of Pakistan. Research Journal of
Management Sciences ISSN, 2319, 1
20. Loening, J. L., Durevall, D., & Birru, Y. A. (2009). Inflation dynamics and food prices in an
agricultural economy: The case of Ethiopia. World Bank Policy Research Working Paper, (4969)

iew
21. Madesha, W., Chidoko, C., & Zivanomoyo, J. (2013). Empirical test of the relationship between
exchange rate and inflation in Zimbabwe. Journal of economics and sustainable
development, 4(1), 52-58.
22. Manamperi, N. (2014). The short and long-run dynamics between inflation and economic
growth in BRICS. Applied Economics Letters, 21(2), 140-145.
23. Monfared, S., & Akin, F. (2017). The relationship between exchage rates and inflation: the case

ev
of Iran. European Journal of Sustainable Development, 6(4).
24. Muche N. (2007): “Macroeconomic Policy, Inflation and Output in Ethiopia,” A paper Presented
at a workshop organized by MoFED in collaboration with the Resident Representative Office of

r
the IMF on February 28, 2007.
25. Nguse, T., Oshora, B., Fekete-Farkas, M., Tangl, A., & Desalegn, G. (2021). Does the exchange

Management, 14(12), 591 er

rate and its volatility matter for international trade in Ethiopia?. Journal of Risk and Financial

26. Ogbuabor, J. E., Orji, A., Manasseh, C. O., & Anthony-Orji, O. I. (2020). Institutional quality and
growth in West Africa: what happened after the great recession?. International Advances in
pe
Economic Research, 26, 343-361
27. Pesaran, M. H., Shin, Y., & Smith, R. J. (2001). Bounds testing approaches to the analysis of level
relationships. Journal of applied econometrics, 16(3), 289-326
28. Rodrik, D. (2008). The real exchange rate and economic growth. Brookings papers on economic
activity, 2008(2), 365-412
ot

29. Semuel, H., & Nurina, S. (2014). Analysis of the effect of inflation, interest rates, and exchange
rates on Gross Domestic Product (GDP) in Indonesia (Doctoral dissertation, Petra Christian
University).
tn

30. Singh, B. K., Kanakaraj, A., & Sridevi, T. O. (2011). Revisiting the empirical existence of the
Phillips curve for India. Journal of Asian Economics, 22(3), 247-258.
31. Stock, J. H., & Watson, M. W. (1993). A simple estimator of cointegrating vectors in higher order
integrated systems. Econometrica: journal of the Econometric Society, 783-820
rin

32. Tabi, H. N., & Ondoa, H. A. (2011). Inflation, money and economic growth in Cameroon. International
Journal of financial research, 2(1), 45-56
33. Tafere, K. (2008). The sources of the recent inflationary experience in Ethiopia. Addis Ababa
University
ep

34. Wollie, G. (2018). The relationship between inflation and economic growth in Ethiopia. Budapest
International Research and Critics Institute-Journal (BIRCI-Journal), 1(3), 264-271.
35. Yismaw, T. G. (2019). Effect of inflation on economic growth of Ethiopia. Journal of Investment and
Management, 8(2), 48-52.
Pr

This preprint research paper has not been peer reviewed. Electronic copy available at: https://ssrn.com/abstract=4473206
 7. Appendix

ed
7.1. Diagnostics test results

Table (11) Heteroskedasticity (ARCH)

iew
Models LM test for autoregressive Df Prob>Chi2
conditional heteroskedasticity
(ARCH)
chi2
Growth 0.209 1 0.6472
Inflation 0.910 1 0.340

ev
Exchange rate 0.100 1 0.751

H0: no ARCH effects vs. H1: ARCH(p) disturbance

Source: Authors estimation result (2022)

r
Table (12): Breusch-Pagan / Cook-Weisberg test for heteroskedasticity
Ho: Constant variance
Growth er
Inflation Exchange rate
pe
chi2(1) 0.11 3.33 0.01

Prob > chi2 0.7380 0.0681 0.9180

Source: Authors estimation result (2022)

Table (13): Model Specification test
ot

Ramsey RESET test using powers of the fitted values

Ho: model has no omitted variables
Growth Inflation Exchange rate
tn

F(3, 6) 1.61 F(3, 10) 0.24 F(3, 5) 4.51

rin

Prob > F 0.2824 Prob > F 0.8632 Prob > F 0.0693

Source: Authors estimation result (2022)

ep
Pr

This preprint research paper has not been peer reviewed. Electronic copy available at: https://ssrn.com/abstract=4473206
 Table (14): Multicolinearity test

ed
Variable VIF 1/VIF

DGDP | 12.36 0.080883

L1.

iew
Inflation 9.91 0.100866

Year 9.71 0.102982

Inflation | 9.18 0.108953

ev
D1.

DEER | 6.57 0.152097

D1.

r
--. 5.11 0.195579

LD.

DFD

Inflation |
er
4.98

4.77

3.73
0.200756

0.209630

0.268250
pe
LD.

Regq 3.72 0.268560

DGDP | 3.62 0.276064

ot

LD.

DTOP 3.35 0.298844

tn

DGDP | 2.68 0.372995

L2D.
rin

DINV 1.75 0.570681

Mean VIF 5.82

Source: Authors estimation result (2022)

ep

Declaration of interest

This paper was supported by the Internal Grant Agency (IGA) of the Faculty of Economics and
Management, Czech University of Life Sciences Prague, grant no. 2022B0008 Economic Governance as a
Pr

Key Determinant of Macroeconomic Development in Africa.

This preprint research paper has not been peer reviewed. Electronic copy available at: https://ssrn.com/abstract=4473206