THE EFFECT OF ETHIOPIAN BIRR DEVALUATION ON SELECTED MACRO ECONOMIC VARIABLES: A VECM APPROACH

Abstract

This study was attempted to investigate the effect of birr devaluation on selected macroeconomic variables of Ethiopia using the quarterly time series data which ranges from the period 1992/93Q2 up to 2018/19Q4. In order to achieve the objectives of the study, the study employed descriptive trend analysis along with econometric tools to investigate the long run and short run relationship among devaluation and selected macroeconomic variables. The results obtained from Augmented Dickey Fuller (ADF) and Philip Perron (PP) tests indicates that all variables were integrated of the same order I(1)and were stationary at first difference. Similarly, the results captured from the Johansen Co-integration tests revealed that there is a long run relationship among the variables. Therefore, these necessitates the use of VECM model, variance of decomposition and impulse response in the analysis of the study. Depending up on the trend analysis and the results from the econometric tools, the study confirmed that real devaluation of birr has positive effect in the short run and negative in the long run in affecting trade balances of Ethiopia but insignificant in both periods. However, it has positive and significant effects on economic growth, consumer price index, broad money supply and foreign direct investment inflows of Ethiopia in the long run but insignificant positive impacts in the short run. In nutshell, it is clear that the large supply of broad money and higher domestic inflations are the worrisome for the country’s economy and negative trade balances in the long run are also the unpleasant news too. So, based on the findings of this study, the researcher suggests that, the Ethiopian government and national bank of Ethiopia might work in collaborations and apply monetary policy tools in combination with the fiscal policy actions in order to avoid the misalignment and insignificant long run and short run impact of devaluation on trade balance of Ethiopia, overcome high domestic inflation and reduce large broad money supply. In addition, to reduce the huge supply of broad money and high inflation in the country’s economy, the national bank of Ethiopia should take the tight monetary policy tools. Moreover, designing an appropriate investment policy, governments should incentivize domestic infant industries through research works, working on export diversification and the value addition on the existing exporting product items and improve the performance of import substituting industries are the necessary conditions to enhance the performance of Ethiopian economy.