The Devaluation Of Ethiopian Currency What Have We Learned Vector Error Correction Model (vecm)

Ethiopia is a small open economy and has been applying exchange rate devaluation as policy instrumentrnrepeatedly. The focus of this study was to look into the theoretical and empirical relationship betweenrnEthiopian currency devaluation, trade balance, Inflation, External debt servicing, and Economic growthrnso as to draw constructive lessons. The study employed trend analysis along with Econometric analysisrnsuch as Johnson co-integration, Vector Error correction model (VECM), Granger causality tests, impulsernresponse function, and forecast error variance decomposition to analysis long run and short-runrnrelationship between variables. These model was estimated using quarterly data for the period rangingrnfrom 1992Q2 to 2017Q4. Depending on trend analysis and the results from econometric tools, this thesisrnconfirmed the hypothesis that currency devaluation will lead to inflationary and high external debtrnservicing. However, it rejected the hypothesis that currency devaluation will boost economic performancernand allow a stable trade balance. It is crystal clear that huge inflation and huge external debt servicingrnare the burdens for the Economy. Similarly, low economic performance and unstable trade balance arernbad news too. Ultimately, the thesis argued that the Devaluation of Birr is inappropriate policyrninstrument for the Ethiopian economy yet.

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