The research had tried to identify co-integration of the
domestic inflation of Ethiopia with the world level. Given this, the studyconsidered effect of world oil price increment on Ethiopian inflation byconsidering time series data from 1981-2012 sourced World Bank. Vector Error
Correction Model was employed to model long run co-integration of variables and
to identify the significant independent variables as well as speed of
adjustment of the long run equilibrium.
Different tests that are pre-conditions
for this model were done by having respective methods. Based on the result
obtained in the long run co-integration model world oil price, household level
and government expenditure of the country, world level inflation and money
supply growth of the country affect the domestic inflation positively as well
as significantly. Given this, world oil price and government expenditure of thecountry affects the domestic inflation positively and in a significant leveleven in the short run. Speed of adjust of deviation from the equilibrium trend
is not as such fast enough. Domestic inflation of Ethiopia is very responsive to
each shock in the world level inflation and world oil price as depicted by the
impulse response graphs.
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