Monetary Policy and the Macroeconomy: The Ethiopian Experience

Abstract

Successful conduct of monetary policy is known to be critical for ensuring macroeconomic stability. The central banking system of Ethiopia has achieved stability neither in prices nor in the foreign exchange market in the recent history. However, it is unclear how monetary policy decisions translate into important macroeconomic outcomes in Ethiopia. This paper uses descriptive tools and econometric estimates from a structural vector autoregression model based on quarterly time series data for 2006-2020 to address this question. It is shown that reserve money, which is the central bank’s operating target, is a weak predictor of macroeconomic goal variables. This observation, allied with the lack of central bank independence, transparency and communication with the public, can help explain the inefficacy of the monetary targeting regime. It is also found that the prevailing structure and development of the financial system is problematic for effective monetary transmission. The results imply that successful monetary policy requires a two- pronged effort: a short-run strategy aimed at revising the monetary policy framework, and a medium- to long-run strategy aimed at reforming the financial services sector.