Monetary Policy and Inflation in Ethiopia

Since the 1990s, inflation in Ethiopia has been increasing and volatile despite various monetary and fiscal policy measures implemented. Inflation rose from 5% in 1990 to over 35% at the end of 1991, before declining sharply to 3.5% in 1995 and thereafter a deflation of 8.5% in 1996. During 2015-2019, inflation hovered around 10% and in 2020-2021, it remained above 20%. To address the issues of high variability and model uncertainty in determining the sources of inflation and the effect of monetary policy on inflation movements in Ethiopia, the study employed Bayesian Moving Averaging and regime-switching technique with both annual and monthly data. We find that movement in international food prices, oil prices, import growth, GDP growth and exchange rate depreciation as the main drivers of Ethiopia’s inflation. In addition, monetary policy implementation over the years had been more accommodating to output expansion to the detriment of price stability. This is partly due to the fiscal dominance in the Ethiopian economy. Therefore, there is the need for increasing access to credit and labour productivity in the agriculture sector, strengthening the environment for private sector participation in the economy are needed to boost domestic production and exports. Further, measures are also needed to improve foreign exchange inflows and reserves. Last but not the least, stronger collaboration between the central bank and the Finance Ministry is required to reduce fiscal policy's supremacy.