Ethiopian Economic Growth under Fiscal and Monetary Policy Shocks: Evidence from a Structural VAR Model

Abstract

The impact of monetary and fiscal policy fluctuations on output has been a prominent area of macroeconomic policy and satiability of the economy. Thus, this study aimed to investigate the impact of monetary and fiscal policy shocks on affecting Ethiopian macroeconomic fluctuations using the annual time series data from 1991 to 2022. The study used a quantitative research approach, and the data were collected from annual reports of the National Bank of Ethiopia (NBE) for monetary policy variables and other control variables, and the Ministry of Finance and Economic Cooperation (MoFEC) for fiscal policy variables. To analyze the data, the study adopted a structural VAR model to compute variance decompositions and impulse response functions. The results of the unit root test show that all variables are stationary at 1st difference with trends, and trend and intercept at a 95% confidence level. The causality test results suggest that real GDP, exchange rate, and trade openness showed bidirectional causality, while Consumer Price Index, gross capital formation, government expenditure, interest rate, and tax revenue show unidirectional causality. The study concluded that the results of variance decompositions and impulsive response function displayed that although monetary policy shocks are relatively more important than fiscal policy shocks in affecting the economic growth of Ethiopia, both policies have an effective impact on economic growth (real GDP) determinations. Therefore, the study suggested that the government of Ethiopia should use an effective monetary and fiscal policy mix to reduce the rate of inflation and to bring stable economic growth to the country.