Sources of inflation in Ethiopia: a dynamic ARDL model

Inflation has recently become a significant obstacle to the Ethiopian government's efforts to achieve economic progress. Consequently, there is an increasing need to identify the sources of inflation in the country. This study, therefore, analyzed the drivers of inflation in Ethiopia using annual data from 1990 to 2020 and employed an autoregressive distributed lag model for analysis. According to the results of the ADF test, all variables are stationary at first difference. Additionally, the bound test results indicated the existence of long-run co-integration between inflation and its determinants. The study found that money supply, exchange rate, and the gross domestic product of the service sector are significant inflation-augmenting variables, whereas the import volume index and budget deficit are inflation-reducing variables in both the short-run dynamic model and the long-run static model. The coefficient of adjustment, 90 percent, indicates that short-run deviations from the average value of the outcome variable would dissipate within one year. Therefore, the government of Ethiopia should promote agricultural and industrial productivity, implement conservative monetary and exchange policies, and increase imports to reduce the current surge of inflation in the country. This research provides critical insights into the drivers of inflation in Ethiopia, offering policymakers a robust analysis of key economic factors influencing price stability. By identifying the money supply, exchange rate, and service sector GDP as primary inflation-augmenting variables and highlighting the counteracting roles of import volume and budget deficit, this study equips decision-makers with a focused understanding of the economic levers they can adjust to control inflation. The findings underscore the importance of adopting conservative monetary and exchange policies and promoting agricultural and industrial productivity, offering a roadmap to mitigate inflation's adverse effects and foster sustainable economic growth in Ethiopia.