The Impact Of Effective Real Exchange Rate On Economic Growth:

Abstract

This study analyzes long run and short run impact of real effective exchange rate on the Ethiopian economy using annual time series data for the period 1974/75-2013/14. By using co integration and vector error correction analysis, the study found that impact of real effective exchange rate on economic growth works through the aggregate demand channel in the short run and the aggregate supply channel in the long-run i.e. decrease/depreciation in the value of the domestic currency promotes economic growth only in the short-run. In the long-run, it discourages economic growth. In addition to short run and long run effect of Real Effective exchange rate this study found key role of government expenditure on brining economic growth in Ethiopia. Government expenditure is found to be statistically significant to explain economic growth in Ethiopia. Variables like financial institutions development (financial deepening) openness index and real interest rate are also found to be statistically significant with the expected sign in explaining economic growth in the long-run. And also the finding approves, in order to get long-term economic growth the country must appreciation real effective exchange rate and increasing public expenditure are the most important tools for sustained increase in Real Gross Domestic Product.