ADDIS ABABA UNIVERSITY SCHOOL OF GRADUATE …

1 ADDIS ABABA UNIVERSITY SCHOOL OF GRADUATE STUDIES THE SOURCES OF THE RECENT INFLATIONARY EXPERIENCE IN ETHIOPIA BY KIBROM TAFERE June, 2008 ADDIS ABABA ADDIS ABABA UNIVERSITY SCHOOL OF GRADUATE STUDIES THE SOURCES OF THE RECENT INFLATIONARY EXPERIENCE IN ETHIOPIA A Thesis submitted to the SCHOOL of GRADUATE Studies of ADDIS ABABA UNIVERSITY in partial fulfillment of the requirements for the Degree of Master of Science in Economics (International Economics)

2 BY KIBROM TAFERE June, 2008 ADDIS ABABA ADDIS ABABA UNIVERSITY SCHOOL OF GRADUATE STUDIES The Sources of the Recent Inflationary Experience in Ethiopia By Kibrom Tafere Approved by the Board of Examiners: _____ _____ Advisor Signature _____ _____ Examiner Signature _____ _____ Examiner Signature Acknowledgement I

3 Would like to forward the deepest of my appreciation and gratitude to my advisor Alemayehu Geda (PhD) for his patience and constructive advice throughout the course of the thesis. Not only did he help me with invaluable advice, I have also learned a lot from him. The brotherly treatment he accorded me has served as an inspiration for the completion of this study. I am in a position where I cannot take the sole credit for the completion of this study. I credit every piece of strength of this study to my advisor and any weakness to myself.

4 I also owe a great deal of gratitude to my family, my friends Henok Asmare, ADDIS Yimer, and Sintayehu Almaw for their moral support. I would also like to thank Muche Netsere for his constructive advice; Abdulaziz Abrar, Getachew Emre and Emerta Getachew for their assistance with the data and providing useful information. Table of Contents Abstract 1. Introduction ---------------------------------------- ---------------------------------------- ---1 Background ---------------------------------------- ---------------------------------------- ---1 Statement of the Problem ---------------------------------------- -------------------------3 Objective of the Study ---------------------------------------- -------------------------5 Significance of the Study ---------------------------------------- -------------------------5 Organization of the

5 Study ---------------------------------------- -------------------------5 2. Macroeconomic Developments ---------------------------------------- ----------------6 General Indicators ---------------------------------------- ----------------------------------6 Growth ---------------------------------------- ----------------------------------6 Inflation ---------------------------------------- ----------------------------------9 Saving and Investment ---------------------------------------- --------------12 Fiscal Developments

6 ---------------------------------------- -----------------------14 Government Revenue ---------------------------------------- --------------14 Government Expenditure ---------------------------------------- --------------15 Monetary Developments ---------------------------------------- -----------------------19 Money Supply ---------------------------------------- -----------------------19 Exchange Rate ---------------------------------------- -----------------------21 Interest Rate ---------------------------------------- -----------------------23 Balance of Payments Developments ---------------------------------------- -----25 Output Supply ---------------------------------------- --------------------------------27 3.

7 Review of Literature ---------------------------------------- --------------------------------29 Introduction ---------------------------------------- ---------------------------------------- -29 Theoretical Literature ---------------------------------------- -----------------------30 Demand-pull Theories of Inflation ---------------------------------------- ---31 Classical/Neoclassical and Monetarist Theories ---------31 Keynesian Theories of Inflation ------------------------------------35 Keynesian-Neoclassical synthesis ------------------------------------36 Cost-push Theories of Inflation ---------------------------------------- -----37 Structural/Post-Keynesian Theories ------------------------------------40 The Scandinavian Approach ------------------------------------41 Kalecki s Approach ---------------------------------------- --------------44 Empirical Literature ---------------------------------------- --------------47

8 Studies of Inflation in Developing Countries ------------------47 Studies of Inflation in Ethiopia ------------------------------------49 Modeling Inflation in Developing Countries ------------------50 4. Methodology ---------------------------------------- ---------------------------------------- -54 Theoretical Model ---------------------------------------- --------------------------------54 The Model ---------------------------------------- ---------------------------------------- -55 Data Analysis ---------------------------------------- -----------------------62 Unit Root Tests ---------------------------------------- -----------------------63 Cointegration and Error Correction

9 ------------------------------------64 Engle-Granger Procedure ---------------------------------------- -----65 Single Equation Error Correction Model ---------------------------66 The Johansen Procedure ---------------------------------------- -----67 Data Source and Description ---------------------------------------- -----69 Data Limitations ---------------------------------------- -----------------------71 Definitions of Variables Used in Estimation ---------------------------71 5.

10 Model Estimation and Interpretation of Results ------------------------------------73 Unit Root Test Results ---------------------------------------- -----------------------73 Cointegration Analysis ---------------------------------------- -----------------------75 Food Price Model ---------------------------------------- -----------------------76 Non-food Price Model ---------------------------------------- --------------81 Single Equation Error Correction Model ---------------------------------------- -----86 6.