Monetary Policy And Macroeconomic Shocks In Ethiopia Specification Estimation And Analysis Of Monetary Policy Reaction Function

Monetary Policy and Macroeconomic Shocks in Ethiopia Specification, Estimation and Analysis of Monetary Policy Reaction Function

This study examines the response of monetary authority to macroeconomic shocks by employing a VECM Cointegration VAR model that considers domestic credit as the most appropriate indicator of monetary policy performance. The main findings of the study are as follows: Both net foreign asset and GDP are statistically significant and positively influence domestic credit in the long run dynamics model. It is only consumer price index that has a positive impact in the short run dynamics. All other explanatory variables negatively influence domestic credit in the short-run dynamics model. The effect of monetization of fiscal deficit on monetary policy depends on the endogeneity and exogeneity of fiscal deficits in the long run dynamics model. Moreover, the speed of adjustment or feedback effect towards long run equilibrium takes many years to make a full adjustment when there is a shock to the system. However, the speed of adjustment is inconsistent comparing with the short run dynamic analysis in this regard. The sterilization coefficient reveals incomplete sterilization activities while the offset coefficient tells us a high degree of monetary control with low degree of capital mobility. Therefore, the study recommends that the monetary authority should exercise its full discretionary power and focuses on financial sector development, secondary market and economic monetization in order to timely respond to macroeconomic shocks through market-based policy instruments.

Aanwinsten van de Centrale Bibliotheek (Queteletfonds)

Monetary Policy and MacRoeconomic Shocks

The study examined responses of Central Bank of Ethiopia to macroeconomic shocks. Macroeconomic shocks in Ethiopia (until 2005) mainly came from non-monetary phenomena of recurrent drought, erratic rainfall, and political stability. To tackle the shocks derived from monetary and non-monetary aggregates, the Bank has been implementing a combination of both accommodating and stabilization monetary policies.The Coefficients of equilibrating error terms in the model suggest that the speed of adjustment/ feedback effect towards long run equilibrium takes many years for full adjustment when there is a single shock in the system, indicating the existence of longer lags structure and undeveloped financial sectors that hindered the effectiveness of monetary policy. The sterilization coefficient revealed incomplete sterilization activities while the offset coefficient tells us a highest degree of monetary control with low degree of capital mobility. Besides, the nonexistence of a well-developed secondary market, lack of latitude to engage in discretionary activities, and the non-monetized part of the economy put a daunting challenge to monetary policy.