Abstract:
Abstract
Background: Monetary policy is the process by which the regulatory authorities, government
and central bank of a country controls the rate of inflation, supply of money, availability of
money and rate of interest in order to achieve a set of objectives that is beneficial for the
strength, stability and growth of the economy. The main objective of this study is to investigate
the relationship between transmission mechanism of monetary policy channel and economic
growth in Ethiopia with the application of multivariate time series analysis approach.
Method: A time series technique using annual data for the period 1972 to 2018 is utilized. The
Johansson co-integration test used to determine the number of co-integration rank in the longrun
relationship and vector error correction model (VECM) used to determine the short run
relationship between real economic growth and monetary policy variables were employed.
Because VAR model represent the correlations among a set of variables, structural VAR analysis
are often used to analyze certain aspects of the relationships between the variables of interest.
The data were analyzed by using R version 3.5.3, Eviews 10 and Stata 15 Statistical software.
Results: Johansson co-integration test revealed that broad money supply, real effective exchange
rate and deposit interest rate have positive and domestic credit has negative effect on real
economic growth in the long-run whereas in the short run broad money supply, real effective
exchange rate have positive but, domestic credit and deposit interest rate have negative
relationship with real economic growth. One standard deviation innovation in real economic
growth has a positive impact on broad money supply and real effective exchange rate and
negative impact on deposit interest rate and domestic credit. The FEVDs result indicates that, at
the first and second horizon most of variation of the series were explained by their own shock.
Conclusion: Monetary policy transmission mechanisms channels are most important in
promoting real economic growth in Ethiopia through creation of modern banking sector, so as to
enhance domestic investment, the instrument to increase output per capital and hence promoting
economic growth in the long-run.
Key word: Real Economic Growth, Monetary Policy Channels, Vector Error Correction Model,
Cointegration, Impulse Response Function and Forecast Error Variance Decompositions.