This study analyzes the impact of real effective exchange rate on the Ethiopian economyrnusing annual time series data for the period 1970-2009. With the help of cointegration andrnvector error correction analysis, the impact of real effective exchange rate on real grossrndomestic product growth was assessed in the long-run as well as in the short-run. The studyrnfound that the impact of real effective exchange rate on economic growth works through thernaggregate demand channel in the short-run and the aggregate supply channel in the long-runrni.e. decrease/depreciation in the value of the domestic currency promotes economic growthrnonly in the short-run. In the long-run, it discourages economic growth. The study also foundrnthat the government, through its spending, may play a key role in bringing about economicrngrowth in Ethiopia. Government expenditure is found to be equally statistically significant tornreal effective exchange rate in explaining economic growth in Ethiopia. Other variables likernreal interest rate and real exchange rate premium are also found to be statistically significantrnwith the expected sign in explaining economic growth in the long-run. The study confirmsrnthat the country is on the right truck to go for a long-term economic growth as thern[appreciation of] real effective exchange rate and [increase in] public expenditure are thernmost important tools of economic growth in the hand of the government. With the use of atrnleast these two tools, the government may play a key role in transforming the agrarianrneconomy.rnKey words: Real effective exchange rate, economic growth.