Effect of Trade Openness on Inflation in Ethiopia (An Auto Regressive Distributive Lag Approach)

Abstract

This study empirically examine the effect of trade openness on inflation in Ethiopia using annual time series data over the period 1970/1971-2010/2011 by applying auto regressive distributed lag(ARDL) model for inflation. The control variables that are included in the inflation equation are gross fixed capital formation, money supply, per capita income and government consumption expenditure. The objective of this study is to test the applicability of Romer hypothesis in Ethiopia. In the contrary to Romer hypothesis the finding of the study indicates that the role of trade openness on reducing inflation is insignificant both in the long run and short run. The result of the study confirms that among the control variables included in the inflation equation, gross fixed capital formation significantly reduce inflation. But money supply, per capita income and government consumption expenditure have a positive and significant effect both in the long run and short run. The most important policy implication that comes out of this study is that the policy makers should focus on measures other than external trade sector such as money supply and government expenditure in devising policies to combat and reduce domestic inflation.