Inflation and Money Growth in Ethiopia: Is there a Threshold Effect?

This study analyses money growth - inflation nexus in Ethiopia using annual datasets covering the period 1970-2009. This period was considered due to data limitations. A significant aspect of the study is that it tries to identify the optimal level of money growth using Two Regime Threshold Model. The result from the two-regime threshold model reveals that there is indeed a threshold effect in the relationship between money growth and inflation and the optimal level of money growth is estimated to be 17% which has an important policy implication. Here, money supply creates inflationary pressures only when it exceeds 17%. A percentage increase in money supply above this threshold value is expected to cause 1.47 percent increase in annual inflation indicating that monetary factors are valid sources of inflation in Ethiopia. The results imply keep the money growth below 17%. Hence, a specific monetary policy measures that could be envisaged is controlling broad money supply (M2).