AN EMPIRICAL INVESTIGATION ON THE RELATIONSHIP BETWEEN INFLATION AND ECONOMIC GROWTH IN ETHIOPIA

Abstract

Generally, high and stable output growth and low inflation are the two main goals of macroeconomic policy. Therefore, it is important to investigate the existence and nature of the link between inflation and growth as a major objective of the study. The data used are annually from 1991 to 2014 on inflation( as measured by percentage change of consumer price index) and economic growth ( as measured by percentage change on annual real gross domestic product). The unit root result shows that the variables are stationary at first difference or they are I (1). The lag length using AIC, SC, HQ shows one lag. The co integration relations were identified by applying Johansen‟s co integration tests. The result of Johansen test indicates the existence of one co integration relation between the variables, meaning there exist a long run relationship between economic growth and inflation in Ethiopia. The Vector Error Correction (VEC) model of lag one with one co integration equations best fits the data. Vector error correction estimates indicate that there is no any short run relationship between economic growth and inflation. The error correction term (speed of adjustment towards equilibrium) shows that any disequilibrium will adjust back to equilibrium by about 80.3%. This shows whatever any deviation from the long run equilibrium will rapidly adjusted or returns back to its equilibrium. The potential causal relations were examined by employing Granger‟s causality tests and the result showed that the causality running from economic growth to inflation, while inflation does not have predicting power about economic growth.