The Impact of Inflation on Economic Growth in Ethiopia

Abstract

Almost all countries consider sustaining high level of economic growth with low level of inflation as their macroeconomic objective. But there has been a debate about the nature of relationship between these two important variables. Motivated by this argument, this study examined the long run and short run relationship between economic growth and inflation. The methodology employed is Autoregressive Distributed Lag Model (ARDL) of Bound test to cointegration for long run analysis and Error Correction Model (ECM) for short run analysis. The scope of the study spanned from 1981 to 2014. Agumented Dicky Fuller test (ADF) and Phillip-Perron test (PP) were used to carried out the stationarity test and the data is stationary at 1%, 5% and 10% level of significance. The bound test reveals the existence of stable long run relationship between inflation and economic growth. Further effort was made to check the causality by employing pairwise granger causality test at different lag length (lag 1 and lag 2). Uni-directional causality which runs from economic growth to inflation is obtained at both periods. A positive relationship was found in the long run and negative short run relationship between these two macroeconomic variables in Ethiopia during the study period. In the short run the coefficient of the error correction term is -0.622, its implication is that about 62.20% of the disequilibrium adjusts to the long run equilibrium after a shock annually. Hence Policy makers should emphasize on policies that enhance economic growth as well as inflation combating measures.