Monetary Policy And The Monetary Approach To The Balance Of Payments The Case Of Ethiopia (196768 - 199900)

This paper empiricallv tests the reserve flow equation of the monetary approach to thernbalance of payments in the case of Ethiopia during the period J967/68 to J999/00 withrnquarterly dies-aggregated data. It examines whether disequilibrium in the money marketrnplayed a role in determining balance of payments deficits. The study employed the JohansenrnMaximum likelihood vector error correction modeling technique. Reserve or balance ofrnpayments is assumed to depend on domestic credit, domestic price, real income, interest rate,rnmoney multiplier and exchange rate variables. Both the vector autoregressive and the vectorrnerror correction mechanisms are estimated to determ.ine the long run and short runrnrelationships of the variables. The empirical result suggests that money played a significantrnrole in explaining balance of payments. The key proposition of the model, which is a one-to -rnone offsetting relationship between reserves and domestic credit is not observed. Instead thernresult suggests that a one percent increase in credit implies a 1.3 percent decline in reserves.rnThe policy implications is that given the assumptibns of the model, balance of payments deficitrncan be improved through appropriate monetary and fiscal policies together withrncomplementary and reinforcing polices that remove supply side rigidities in the Ethiopian economy.

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