Determinants of Inflation in Ethiopia: Autoregressive Distributed Lag Model

Price stability is one of the major goals of monetary policy and the key indicators of macroeconomic stability. Pursuing of price stability is primary to long-run growth and development; it should be the concern of every economy. This study examine the factors in determining inflation in Ethiopia, using the autoregressive distributed lag (ARDL) model by employing the data series for the period ranging from 1974 to 2017. The ADF Unit root test confirmed that the variables in the model are integrated of order 0 I (0) and order one I (1)). The Bound F-test of co integration has confirmed the existence of long run relationships among the variables entered in the inflation model. ARDL regression result suggest that real gross domestic product, real effective exchange rate and budget deficit variables are important in determining inflation in the short run. In the long run inflation is determined by real effective exchange rate, budget deficit, gross national saving and lending interest rate. The error correction term coefficient is negative and significant at 1 percent level of significance suggesting that inflation adjusts to deviations from its long -term equilibrium. The estimated model passes diagnostic tests and the graphical evidence (CUSUM and CUSUMQ graphs) indicate that the model is stable during the sample period. Finally, investments in food and agricultural sectors could considerably support the process of ensuring price stability. Moreover, a credible and sustained fiscal adjustment, aiming to boost revenue generation can reduce fiscal deficit.