This study attempts to investigate the effect of exchange rates on economic growth in Ethiopia using annual time series data spanning from 1985/86 to 2014/15. The explanatory variables in this study were real effective exchange rate, government final consumption expenditure, gross fixed capital formation, broad money supply and trade openness. The multilateral real exchange rates is used to measure real exchange rates.
Results from Vector Error Correction Model revealed that real effective exchange rates, broad money supply and trade openness have a positive long run effect on economic growth, while government final consumption have a negative long run effect on the economic growth of Ethiopia. From the regression results, it was noted that undervaluation of the currency is contractionary in the long run and neutral in the short- run. As such, the effect of exchange rates on economic growth works through the supply channel. It is the reflection of various economic and policy shocks, mainly a strategy shifts, of the government.
Based on the findings of this study, the researcher recommended that since the Ethiopian output is dominated by primary agricultural products and it is insensitive for the change in exchange rate. Government intervention is needed to balance the adverse effect of exchange rate movements until the economy well transformed from agricultural lead economy to industrial lead economy and becomes less dependent on imported raw materials.
Table of Contents
CHAPTER ONE: INTRODUCTION
1.1. Background of the Study
1.2. Statement of the Problem
1.3 Objective of the Study
1.4 Basic Research Questions
1.5 Hypothesis
1.6 Significance of the Study
1.7 Scope and Limitation of the Study
1.8 Organization of the study
CHAPTER TWO: LITERATURE REVIEW
2.1 Brief discussion of exchange rate in Ethiop
2.1.1 Definition
2.1.2 Exchange rate policy in Ethiopia
2.1.3 Exchange rates and economic growth in Ethiopia
2.1.4 Real and nominal effective exchange rates
2.2 Theoretical literature review
2.2.1 The traditional views of Exchange rate
2.2.2 The structuralist views of Exchange rate
2.2.3 The Balassa-Samuelson Hypothesis
2.2.4 The export-led growth hypothesis
2.3 Empirical literature review
CHAPTER THREE: DATA AND METHODOLOGY
3.1 Introduction
3.2 Research Design
3.3 Data type and sources
3.4 Method of data analysis
3.5 Model specification
3.6 Unit root tests
3.7 Johansen cointagration test and VECM
3.8 Impulse response and variance decomposition analysis
3.9 Diagnostic checks
CHAPTER FOUR: EMPIRICAL ANALYSIS AND DISCUSSION
4.1 Introduction
4.2 Descriptive data analysis
4.2.1 Real effective exchange rate and economic growth
4.3 Tests of the time series data
4.3.1 Stationarity tests
4.4 Test for cointegration
4.5 Determination of optimal lag length
4.6Estimation results and interpretation
4.6.1Vector Error Correction Model
4.7 Diagnostic tests on the residuals of VECM
4.8 Impulse response and variance decomposition analysis
CHAPTERFIVE: SUMMARY, CONCLUSIONS AND RECOMMENDATIONS
5.1 Summary of the Findings and Conclusions
5.2 Policy implications
Research Objectives and Key Topics
The primary objective of this thesis is to empirically investigate the long-run and short-run effects of exchange rate adjustments on economic growth in Ethiopia, utilizing annual time series data covering the period from 1985/86 to 2014/15.
- The impact of real effective exchange rates on national economic performance.
- Evaluation of government fiscal policy and expenditure relative to GDP growth.
- Analysis of the relationship between trade openness, broad money supply, and economic output.
- Application of the Vector Error Correction Model (VECM) for macroeconomic forecasting.
- Strategic assessment of Ethiopia's shift from an agricultural-led to an industrial-led economy.
Excerpt from the Book
2.2.1 THE TRADITIONAL VIEW OF EXCHANGE RATES
This view holds that devaluation have expansionary effects on economic growth. This is popularly known as the traditional view. This approach holds that devaluation of a currency will cause local goods to be cheaper abroad and this will increase their demand, leading to an increase in exports (Salvatore, 2005). The view that devaluation has expansionary effects on output is evident in that devaluation of the currency improves trade balance, alleviates balance of payments difficulties and accordingly expands output and employment (Acar, 2000). The case for devaluation is that when a country devalue its currency, it enhances the cost competitiveness of its exports which are a component gross domestic product.
The traditional approach to exchange rates assumes that exchange rates affect economic growth through two main channels; the Total Factor Productivity growth channel and the Capital accumulation channel.
I. THE TOTAL FACTOR PRODUCTIVITY GROWTH CHANNEL
The Total Factor Productivity growth channel holds that currency depreciation shifts the output composition of a country from the production of non-traded goods to traded goods. The link from output composition to growth is through economy-wide productivity improvements, generated by the production of some types of traded goods (exported manufactured goods) through mechanisms such as technology and skill transfers associated with learning by doing that is external to the firm (Montiel and Serven, 2008). This shift to the production of traded goods and improvements technology results in an increase in investments locally, exports and ultimately economic growth. The Total Factor Productivity growth channel places the structure of domestic production at the core of the argument (Eichengreen, 2008). A depreciated real exchange rate, equivalent to an increase in the price of tradables relative to non tradables, improves the profitability of the tradable sector. As production moves from the non tradables to the tradable sector characterized by higher (marginal social) productivity levels the overall productivity in the economy increases. Such economy-wide productivity improvement ultimately fosters growth (Mbaye, 2012).
Summary of Chapters
CHAPTER ONE: INTRODUCTION: Introduces the background, problem statement, objectives, and significance of studying the effects of exchange rate adjustments on the Ethiopian economy.
CHAPTER TWO: LITERATURE REVIEW: Examines theoretical frameworks, including traditional and structuralist views of exchange rates, the Balassa-Samuelson Hypothesis, and empirical findings from other developing countries.
CHAPTER THREE: DATA AND METHODOLOGY: Details the research design, data sources, model specification, and econometric methods like unit root tests and the Vector Error Correction Model.
CHAPTER FOUR: EMPIRICAL ANALYSIS AND DISCUSSION: Presents descriptive statistics, stationarity tests, cointegration results, and the econometric interpretation of the variables' impacts on economic growth.
CHAPTERFIVE: SUMMARY, CONCLUSIONS AND RECOMMENDATIONS: Synthesizes the empirical findings, concludes on the long-term impact of exchange rate policies, and provides policy recommendations for Ethiopia's economic transformation.
Keywords
Exchange Rates, Economic Growth, Ethiopia, Devaluation, Real Effective Exchange Rate, VECM, Trade Openness, Gross Domestic Product, Macroeconomic Policy, Structural Adjustment, Capital Accumulation, Export-led Growth, Monetary Policy, Fiscal Policy, Inflation.
Frequently Asked Questions
What is the primary focus of this research?
The research investigates the influence of exchange rate movements on Ethiopia's economic growth using historical time series data.
Which economic theories are analyzed in the work?
The study evaluates the traditional view of currency devaluation, the structuralist approach, the Balassa-Samuelson Hypothesis, and the export-led growth hypothesis.
What is the core research question?
The study primarily asks whether exchange rate adjustments have a significant long-run effect on economic growth in Ethiopia.
Which methodology is employed for empirical analysis?
The author uses a quantitative research design, specifically applying the Vector Error Correction Model (VECM) to estimate long-run and short-run relationships.
What is covered in the main body of the text?
The main body covers the literature review, the derivation of the econometric model, the diagnostic testing of the data, and the empirical results regarding variables like GDP, inflation, and trade openness.
Which keywords best describe this study?
Key terms include Exchange Rates, Economic Growth, Ethiopia, Devaluation, VECM, and Trade Openness.
Does currency depreciation promote growth in Ethiopia according to the results?
The results suggest that, contrary to traditional expectations, devaluation is contractionary in the long run for Ethiopia, implying that exchange rate stability is crucial.
What role does government final consumption expenditure play?
The study finds a significant negative long-run relationship between government final consumption expenditure and economic growth in Ethiopia.
- Citation du texte
- Muluken Nigussie Tessema (Auteur), 2016, The effect of exchange rates on economic growth in Ethiopia, Munich, GRIN Verlag, https://www.grin.com/document/537795
