The Impact of International Price Shock Transmission on the Ethiopian Economy: VECM and CGE Modelling Approaches

Abstract

This study examines the impacts of selected cash crops (coffee and oilseeds) international price
shock transmission on Ethiopia’s macro economy in general and households’ welfare in
particular, which is transmitted to the domestic market via sales tax or value added tax. For the
analysis, we employed the Vector Error Correction Model (VECM) and the Stage Computable
General Equilibrium (CGE) Model. The VECM result confirms that international and domestic
prices for both commodities have a long-term association and the domestic price is more elastic
than the international price. The Stage CGE Model simulation result portrays that the positive
shock transmission to domestic prices (domestic price increment) slows down the macroeconomic performance of the country (GDP, government consumption demand, household
consumption, investment demand, export and import) and vice versa. Moreover, households’
welfare is better off when domestic prices of coffee and oilseeds rise and worse off when they
fall, as the equivalent variation increases when prices rise and decreases when prices fall. The
research result implies that policy makers need to investigate the international price trends of
exportable commodities so as to forecast and design appropriate policies that assure the welfare
of households and macro-economic stability. It is also recommended to formulate policies that
enhance productivities, especially agricultural productivity, to offset fully or at least partially
impacts on the macro-economy and households’ welfare.