Nexus between Economic Growth, Unemployment and Inflation in Ethiopia

Abstract

Empirical literature reveals that the fast-economic growth in Ethiopia during 2004-2016, averaging 10.6 percent, was affected by inflationary and unemployment pressures. The question of how to maintain low and stable unemployment and price levels and achieve high economic growth were a puzzle for policy makers in Ethiopia. The objective of this study was to investigate the short-run and long run relationships and causalities among inflation, unemployment and economic growth in Ethiopia. The time series data from World Bank: World Development Indicator databases, for the period 1991–2016, were employed. Autoregressive Distributed Lag bounds testing for cointegration and Error Correction Model were used for the analysis. The results indicated the existence of a long run relationship among the variables. In the short-run, a single digit rise in price promotes economic growth in Ethiopia. There is a short run causality running from inflation to real Gross Domestic Product; and in the long run economic growth and inflation move together. The short run, long run and ECM estimates all agree over significance and causation: inflation and unemployment estimates have inverse and significant relationship while inflation and GDP have positive and significant relationship. The speed at which inflation returns to equilibrium after changes in unemployment and real GDP, as measured by ECM, is 112 percent, indicating the strength of the economy’s ability to accommodate shocks. Since unemployment and GDP have diverse and opposite effects on inflation, policy choices need to be taken with care and vigilance.