Tuesday, March 26, 2013

NEVIS Review No 13 Section II, Ref # 13.2

NEVIS Review No 13
Section II
Ref # 13.2
March 25, 2013

Inflation and economic growth: an estimate of the threshold level of inflation
By Emerta Asaminew

Although Ethiopia has been a low inflation country, recently, double digit inflation has become one of the main macroeconomic concerns of policy makers and the society. By adopting the threshold approach, this paper is primarily meant to estimate the optimal level of inflation in Ethiopia around which inflation affects economic growth optimally. Applying this modeling technique on the data from 1970-2010, this paper established that inflation level of about 8-10 percent is optimal for Ethiopia. Any inflation level significantly above or below this level may be a deterrent to a long-term and sustainable economic growth. Hence, the monetary authority (National Bank of Ethiopia) should work to maintain the inflation level close to the threshold level. Good monetary and fiscal contributions are also needed to maintain the inflation level around the desirable range. The inflation target of 6 percent set in the GTP may not only be so ambitious, given the current context of the Ethiopian economy, but also a little below our threshold estimate. The estimation result is robust to alternative specification

The estimation procedure gave some interesting results. First, only the second period lag of inflation affects economic growth significantly. Second, we found a non-linear relationship between growth and inflation in Ethiopia over the period 1971-2010. Third inflation level within the range of 8-10 percent is optimal for economic growth. The estimation result is robust to choice of variables and estimation technique.
The findings also have important policy implications. First inflation is not generally harmful for growth in Ethiopia. Second, the monetary authority should keep the inflation level with in the single digit level, but lower than our estimate. Third, the inflation target of 6 percent for the period of GTP is not only very low, but also ambitious given the recent state of the economy and the planned projects. Fourth, the policy advice of the international lending agencies of reducing the inflation level to a very low level (close to zero) are likely to adversely affect economic growth.

(Source- Proceedings of the ninth international conference on the Ethiopian economy, Volume II,  Ethiopian Economics Association, June 2012)