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Do Capital Inflows Hinder Competitiveness? The Real Exchange Rate in Ethiopia


  • Pedro M. G. Martins

    () (Institute of Development Studies (IDS), University of Sussex)


This paper investigates the determinants of the real exchange rate (RER) in Ethiopia. In particular, it assesses whether large capital inflows (e.g. foreign aid and remittances) have an impact on the RER. This empirical exercise tries to improve the current literature in a number of ways: (i) the use of quarterly data provides a larger sample size and enables the modelling of important intra-year dynamics, which should lead to better model specifications; (ii) the use of several cointegration approaches allows interesting methodological comparisons; and (iii) the use of a time series model (Unobserved Components) provides a new empirical approach and a robustness check on the econometric models. The results suggest two main (long-run) determinants of the RER in Ethiopia: trade openness is found to be correlated with RER depreciations, while a positive shock to the terms of trade tends to appreciate the RER. Foreign aid is not found to have a statistically significant impact, while there is only weak evidence that workers’ remittances could be associated with RER appreciations. The lack of empirical support for the Dutch disease hypothesis suggests that Ethiopia has been able to effectively manage large capital inflows, thus avoiding major episodes of macroeconomic instability.

Suggested Citation

  • Pedro M. G. Martins, 2010. "Do Capital Inflows Hinder Competitiveness? The Real Exchange Rate in Ethiopia," Working Paper Series 1110, Department of Economics, University of Sussex.
  • Handle: RePEc:sus:susewp:1110

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    More about this item


    Real Exchange Rate; Foreign Aid; Time Series Models; Africa;

    JEL classification:

    • C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes
    • F35 - International Economics - - International Finance - - - Foreign Aid
    • O24 - Economic Development, Innovation, Technological Change, and Growth - - Development Planning and Policy - - - Trade Policy; Factor Movement; Foreign Exchange Policy
    • O55 - Economic Development, Innovation, Technological Change, and Growth - - Economywide Country Studies - - - Africa

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