Are Fiscal Deficits Really Inflationary? An Investigation into Ethiopian Experience

Abstract

Ethiopian macroeconomy has been characterized by enormous disequilibria explained by galloping inflation, increasing unemployment, inadequate balance of payments, mounting burden of debt and fluctuating output. Only recently the country’sincome growth is reported to register relatively stable rate, leaving other indicators unsteady. This study establishes long-run relation between budget deficits and inflation while controlling for money supply, owing to the justified links between deficits and money supply especially across developing countries. The study employed time series data with temporal coverage of 1980-2018. Augmented Dickey Fuller has tested nonstationary for all series, but with all stationary at first difference.Engle-Granger (1981) approach tested long-run relation between budget deficits, money supply and inflation. Due to Laney and Willet (1983) the conventional least squares method was adopted to establish long-run relation among the three variables. The long-run results evidencedthat fiscal deficits and money supply have been at the root of galloping inflation in Ethiopia. There is also evidence that, budget deficits have been the root cause of money supply growth in Ethiopia; while giving support to a view that, governments of less developing countries resort to monetize large portion of their deficits.There is need to reform the fiscal aspect of the government, if the mounting rate of deficitshas to be lessened. Budgetary imbalances can be rectified throughenhancementof domestic capital market and setting limits on central bank borrowing. Besides, it could be vital to expandthe tax baseas well asintensify efficiency ofthe existing tax system in the country.