Effectiveness of National Bank of Ethiopia in Choosing Appropriate Intermediate Target

Abstract

The study assesses the effectiveness of National Bank of Ethiopia in choosing appropriate intermediate targeting framework by examining the stability of long run money demand function from 1981 to 2014. To examine the stability of money demand the study used real gross domestic product (RGDP) as scale variable, saving deposit rate (Rt) as opportunity cost variable, average exchange rate (Ex) as indicator of openness of economy, and real money demand measured by (M2/Pt).The study used ADF unit root test, the Johansen and Juselius (1990) Co-integration, error correction model (ECM), and CUSUM and CUSUMSQ stability tests. The results of long run regression indicated that real broad money demand had positive and highly significant relationship with RGDP and exchange rate whereas saving interest rate has negative and insignificant relationship. In addition CUSUM and CUSUMSQ stability tests of long run money demand function showed the evidence for parameter stability. However, the short run model indicated instability of the parameters. Thus, monetary targeting framework based on broad money supply (M2) can be appropriate intermediate target of monetary policy in Ethiopia. This implies that national Bank of Ethiopia is Effective in choosing intermediate monetary policy target. In short run, however, monetary policy authority can better target multiple macroeconomic indicators.