This paper examines the role of real and nominal disturbance in explaining the movement ofrnreal exchange rate in Ethiopia and assess whether the nominal effects are permanent orrntransitory. The study also tried to see the extent of exchange rate misalignment.rnIn estimating the model, we first test for the time series properties of the model and indicate thernorder of integration. The ADF tests, for unit root, showed that all variables except governmentrnconsumption, nominal devaluation and excess credit are integrated of order one. Johansen 'srnlikelihood ratio is employed for co-integration tests and these tests revealed that there is onernco-integrating vector.rnrnThe test for weak exogeneity also reveal that except real exchange rate and terms of trade all ofrnthe variables are found to be weakly exogenous in the official exchange rate based REERrnspecification but all the variables except the dependant variable (weighted real exchange rate)rnare weakly exogenous in the weighted exchange rate based REER specification. Findings inrnthis paper show that the main long run determinants of real exchange rate in Ethiopia arernterms of trade, government consumption, capital flow and import tariffs. However, thernestimated error correction model shows that nominal devaluation and domestic credit havernsignificant effect on the real exchange rate in addition to the above stated variables.rnThese findings indicate that trade and exchange rate liberalization have lead to depreciation inrnthe real exchange rate which in turn boosts exportable and improved the countryâ€™s BOPsrnposition. contractionary monetary policy also contributed significantly much in improvingrnexchange rate stability.