Supply and Demand Side Determinants of Inflation in Ethiopia: Auto-Regressive Distributed Lag Model (ARDL)

Abstract

Inflation is defined as a persistent increase in general price level of goods and services. Even though Ethiopia has experienced a low inflation until 2008, recently, double digit inflation has become troublesome for policy makers as well as the society. So, this study tried to examine the supply and demand side determinant of inflation in Ethiopia by employing the techniques of Auto-Regressive Distributed Lag Model (ARDL) for 32 years’ data spanning from 1985 to 2016. The study included macroeconomic determinant that alter or change inflation level measured by consumer price index such as money supply, real gross domestic product, world oil price, budget deficit and real effective exchange rate. The results of bound test confirmed that the long run relationship between explanatory variables and consumer price index in Ethiopia. The empirical results implied evidence of a long-run positive impact of money supply, world oil price, budget deficit and real effective exchange rate on inflation in Ethiopia whereas as real gross domestic product insignificantly affect price level . Finally, from the finding of our study in the short run, real effective exchange rate, money supply budget deficit and world oil price are the main determinant of inflation in Ethiopia. Given these findings, the effectiveness of fiscal deficit and exchange rate as well as contractionary monetary policy as a mechanism of price stabilization in the long run and short run is recommendable for policy inference.