Inflation and Economic Growth: Inflation Threshold Level Analysis for Ethiopia

Transcription

1 Inernaional Journal of Ehics in Engineering & Managemen Educaion Websie: (ISSN: , Volume 2, Issue 5, May 2015) Inflaion and Economic Growh: Inflaion Threshold Level Analysis for Ehiopia Dr.P.Nandeeswara Rao Ass.Professor, Hawasaa Universiy,Ehiopia. Abae Yesiga Head, Deparmen of Economics Hawasaa Universiy, Ehiopia Absrac: One of he main objecives of macroeconomic policy of he Ehiopian economy is o aain susainable economic growh ogeher wih sable price level. However, in recen imes he counry has been experiencing an increase in price level and he siuaion has go wide range of concern regarding is effec on economic growh. Hence, he cenral focus of his research is o look ino he naure of inflaion-economic growh relaionship of Ehiopia from 1974 o 2012, specifically by using he framework of Vecor Auo Regressive (VAR), Error Correcion Mechanism(ECM), causaliy es and hreshold level analysis using annual daa covering he period from 1974 o All he variables are esed for uni roos using Augmened Dickey Filler (ADF) es and he es resuls revealed he variables are saionary a heir firs difference. The resuls of co inegraion es, using Johansen Maximum likelihood approach, indicae he exisence of long run relaionship among he variables enered in he models. The Granger Causaliy Tes found he bidirecional causal relaionship beween inflaion and economic growh. And he resul also reveals he negaive relaionship beween inflaion and economic growh in Ehiopia boh in he shor and long run. The hreshold model esimaion recommends 9-10 percen hreshold inflaion level, which is opimal for economic growh. Above his level inflaion affecs economic growh negaively. Therefore, conrolling moderae inflaion should be he main goal for policymakers in Ehiopia. Finally, hough he research achieved he objecives menioned, lack of quarerly daa on many imporan macroeconomic variables ac as a limiaion of he sudy. Keywords: Economic Growh, Inflaion Vecor Auo Regressive, Threshold level in Ehiopia INTRODUCTION The aim of any counry is o achieve rapid and susainable economic growh. Meanwhile, for his ype of growh o occur, here is he need o have sable macroeconomic environmen. However, achieving macroeconomic sabiliy, such as, low rae of inflaion, manageable rade and balance of paymens deficis, higher saving and invesmen rae o finance long run economic growh is challenging in developing counries. This problem has become even more complex in oday s world of globalizaion where developing counries are prone o furher underdevelopmen if he necessary policy-mix is no prudenly formulaed and carefully implemened (Ahoror, 2009). 1 Hence, one of he mos pressing issues, which affec macroeconomic sabiliy in mos of he developing counries, is inflaion. Worldwide inflaion is recenly rising, due o higher energy and food price, rapidly rising demand in emerging economies, poor harves in commodiy producing counries, and diversion of food crops o producion of biofuels. For insance, in Augus 2009 World, Emerging and Developing, and Sub Saharan Africa -inflaions were 2.3%, 5.5% & 9.5%, bu in Augus 2011 i increased o 4.9%, 7.6% and 11% respecively (IMF, 2011). The concern abou inflaion emanaes no only from he need o macroeconomic sabiliy, bu also from he fac ha inflaion his he sociey of a given economy specially he poor, injec noise ino he price sysem, makes long erm financial planning more complex, undermined public confidence in he economy and in he managemen of economic policy generally (Ahoror, 2009). In addiion o his, high inflaion resuls in decline in privae invesmen (boh domesic and foreign invesors lose confidence and become relucan o inves in he economy), rise he relaive price of domesically produced producs and hence reduce he counry s inernaional compeiiveness and leads o balance of paymens problem, reduce real income of he people, reduce saving and in urn resul in low invesmen (Isakova, 2007). Hisorically, he Ehiopian economy was known for is low inflaion. Prior o 2003/04, he counry has no suffered from high inflaion. Since 2004, however, he economy has deviaed from is hisorical rends of sable price and inflaion rose from 3.3 percen in 2004/05 o as high as percen in 2008/09 (NBE, 2010). Similarly, over he long period of ime he Ehiopian economy was known by is slow growh rae and highly dominaed by he agriculural secor, which conribues more han 50 percen of he GDP. However, for he las few years, Ehiopian economy has shown coninuous and high growh rae. For insance, beween 2004/05 and 2009/10 real GDP grew by more han 11 % on average (MoFED, 2010). Saemen of he Problem Globalizaion, privaizaion and liberalizaion policies of he world have made o become a global village all he world counries. Since every counry has o face heavy compeiion, go far informaion echnology, faser communicaion and

2 Inernaional Journal of Ehics in Engineering & Managemen Educaion Websie: (ISSN: , Volume 2, Issue 5, May 2015) faser delivery of goods and services has become mandaory for all he counries. In his scenario he counries in he world are hinking o sabilize heir economy. As a par of his for susainable developmen Ehiopia is hinking in a posiive way o sabilize is economy since i s a developing counry. Keeping in mind his objecive majorly. One of he fundamenal objecives of macroeconomic policies in boh he developed and developing economies is o susain high economic growh ogeher wih low inflaion. Likewise, one of he mos fundamenal objecives of macroeconomic policies in Ehiopia is o susain high economic growh ogeher wih low, single-digi inflaion as saed in he fiveyear Growh and ransformaion plan so as o mainain macroeconomic sabiliy and o boos saving and invesmen (MoFED, 2010). The exisence of high inflaion under double-digi economic growh seems conradicory siuaion and puzzling for he policy makers and for he socieies a large. Moreover, he increasing price has also become derimenal o he lowincome groups and reirees who live wih a fixed income. This siuaion has go wide range of debae regarding he relaionship beween inflaion and economic growh among differen sockholders. They also argued ha he upsurge in inflaion migh adversely affec economic growh ha he counry has experienced recenly. As a resul, various direc and indirec moneary and fiscal policy measures were aken (like increases he reserve requiremen, increasing he deposi rae, insiued credi resricions and ohers fiscal policy measures). However, hese policy responses were carried ou wihou a deailed research on he opimal level of inflaion. Furhermore, boh heory and empirical evidence indicae ha here is no sraighforward and one-sided relaionship beween inflaion and economic growh. Theoreically, he phenomenon of inflaion and economic growh relaionship has been discussed ever since he appearance of classical economic heory and been furhered laer on as he developmen of modern economic heories. Keeping in view afer 1930 s grea depression, in 1936, he high governmen involvemen was suggesed o adjus he marke failure. The higher governmen spending in various aciviies simulaes higher consumpion or invesmen spending which aracs higher price for goods and services in he economy. The higher desire for spending encourages producer o produce goods and services ha demanded by he consumers. Such siuaion enables he counry o achieve economic growh wih higher inflaion.. This siuaion challenged he effeciveness of higher governmen spending in sabilizing he economy. A his ime, he neo-liberal argumen dominaed he world. In heir argumen, neo-liberal believes ha inflaion and economic growh have negaive relaionships. The higher inflaion reduces invesmen and foreign reserve ha lead o lower economic growh. Bu he laes sudy conduced by a number of researchers produced differen oucomes regarding he relaionship beween inflaion and economic growh. The resuls of previous empirical lieraure boh in he conex of developed and developing counries have also suppored he complexiy of his issue. Pu differenly, differen empirical 2 sudies boh in developed and developing counries has also showed differen resuls such as; no-relaionship (Daa and Kumar, 2011), negaive relaionship (Barro, 1995; Ahmed and Moraza, 2005) and posiive relaionship (Mallik and Chowdhury, 2001) beween inflaion and economic growh. Despie he considerable disagreemen in he lieraure, a recenly emerging research agreed on some aspec of heir relaionship. Specifically, he non-linear relaionship is becoming obvious. However, he level of inflaion which is growh discouraging is inconclusive and depends on counry specific characerisics. Therefore, he quesion is; how low should inflaion be? Or pu in differen words; is here a level of inflaion a which he relaionship beween inflaion and economic growh becomes posiive? The hypohesis is ha; a some low rae of inflaion, he relaionship beween he wo variables is non-exisen, or perhaps even posiive, bu a higher raes i becomes negaive. As Khan (2001) pus i, if a relaionship beween inflaion and economic growh exiss, hen i should be possible in principle o esimae he inflexion poin, or hreshold. In an effor o esablish he impac of inflaion on growh and provide an esimae of he inflaion level ha can suppor he growh process, his paper inends o esimae an opimal inflaion level ha is consisen wih a high growh performance. We will analyze he non-linear ineracion beween inflaion and growh using a non-linear leas squares approach, which allows esimaing he hreshold level of inflaion and formally esing is significance. To alleviae he problem of endogeniy, VAR mehod of analysis will be employed. Afer confirming he robusness of he esimaion resul using alernaive approaches, he economy could benefi if he moneary auhoriy arge inflaion around his hreshold level. Thus, he quesions ha his paper seeks o answer include he following. Wha is opimal (hreshold) inflaion level ha is consisen wih high economic growh performance in Ehiopia? Wha is he causaliy beween inflaion and economic growh in Ehiopia? Uni-direcional or bidirecion? Wha is he effec of inflaion on economic growh of Ehiopia? Objecives of he sudy The general objecive of he sudy is o esimae an (hreshold) opimal inflaion level ha is consisen wih a high economic growh performance. Specific Objecives: To invesigae empirically he direcion of relaionship beween inflaion and economic growh To empirically examine he shor-run and long run effecs of inflaion on economic growh of Ehiopia. To give possible policy recommendaions based on he finding.

3 Inernaional Journal of Ehics in Engineering & Managemen Educaion Websie: (ISSN: , Volume 2, Issue 5, May 2015) METHODOLOGY Theoreical framework and model specificaion The phenomenon of inflaion and is effec on real economic variables has been discussed ever since he appearance of classical economic heory and been developed laer on as he developmen of modern economic heories. In his secion, here will be a review of differen economic heories, and he focus in his case is on he explanaions of inflaion and is effec on economic growh. Classical growh heory: Adam Smih who poined a supply side driven model of growh laid he Classical growh model. He viewed saving as a creaor of invesmen and hence growh. Therefore, he saw income disribuion as being one of he mos imporan deerminans of how fas (or slow) a naion would grow. He also posied ha profis decline no because of decreasing marginal produciviy, bu raher because he compeiion of capialiss for workers will bid wages up. The link beween he change in price levels (inflaion) and is effecs on profi levels and oupu were no specifically ariculaed in classical growh heories. However, he relaionship beween he wo variables is implicily suggesed o be negaive, as he reducion in firms profi levels hrough higher wage coss. Pu simply, according o classical explanaion inflaion affecs economic growh negaively (Gokal and Hanif, 2004). Keynesian growh heory: In he framework of Keynesianism, he aggregae demand (AD) and aggregae supply (AS) curves are adoped o show he relaionship beween oupu and inflaion. According o Keynesian, in he shor run, he AS curve is upward sloping raher han verical. If he AS curve is verical, changes on he demand side of he economy affec only prices. However, if i is upward sloping, changes in AD affec boh price and oupu. This holds wih he fac ha many facors, such as expecaions, prices of oher facors of producion, fiscal and moneary policy, drive he inflaion rae and he level of oupu in he shor-run. When he general prices increase Producers of a cerain produc feel ha only he prices of heir producs have increased while he oher producers are operaing a he same price level. However, in realiy overall prices have risen. Thus, he producer coninues o produce more and oupu coninues o rise. I reveals ha according o Keynesian here exiss a posiive effec of price increase on oupu a leas in he shor-run (Snow don, 2005). Monearis growh heory: Moneariss linked inflaion and economic growh by simply using he quaniy heory of money, by equaing he oal amoun of spending o he oal amoun of money in he economy. This can be shown as below by aking Velociy of money consan in he shor run: Y M P = (1) Y M P 3 Y -he growh rae of oupu, Where: Y of money supply and M -he growh rae M inflaion. The above equaion P P indicaes unambiguously negaive relaionship beween inflaion and economic growh (Dornbusch and Fischer, 2001). Neo-classical and endogenous growh heories: Mundell (1963) and Tobin (1965) have explained he effec of inflaion on economic growh based on neo-classical growh heory. They depic a posiive relaionship beween inflaion and economic growh by assuming ha real money balance and invesmen are subsiue. Thus when inflaion is high, i will decrease he reurn on real money balances bu he reurn on invesmen will increase and people subsiue real money balance by invesing on oher asses. This increases capial accumulaion and he economic growh and i will show posiive relaionship beween inflaion and economic growh. Conrary o he conclusion of he Mundell-Tobin effec, Sockman (1981) develops a long-run equilibrium growh model wih assumpion of cash-in-advance consrain. In he model of Sockman (1981), he wo variables relaionship is complemen, accouning for a negaive relaionship beween he seady-sae level of oupu and he inflaion rae. Sockman models his cash invesmen as a cash-in-advance resricion on boh consumpion and capial purchases. Since inflaion erodes he purchasing power of money balances, people reduce heir purchases of boh cash goods and capial when he inflaion rae rises. Correspondingly, he seady-sae level of oupu falls in response o an increase in he inflaion rae. Also reurn o labor falls when he inflaion rae rises. As such, people subsiue away from consumpion o leisure, because he reurn on labor falls and his in urn reduce economic growh. Thus, his sudy has used he combinaion of he above heory so as o develop he heoreical framework ha helps o examine he effec of inflaion on economic growh. According o he endogenous growh model, which is he exended form of he neo-classical growh model, producion funcion is given as: Y = F( K, L, H) Where, Y K, L & H (2), are levels of oupu, physical capial, labour force and human capial respecively and hese variables are known as supply-driven inpus (Dornbusch and Fischer, 2001,Romer,1996). Moneariss link inflaion wih economic growh using he quaniy heory of money as can be seen from equaion (1) above. Economic growh in addiion o supply driven facors depends on demand side variables. Thus, a heoreical framework, which helps o examine he effec of inflaion on economic growh, can be specified as follow by including boh supply and demand variables. RGDP = β 0 + β1 PK + β2lf + β3hcd + β4cpi+ β5m2 + β6opp β7 REER + β8dd + µ...( 3) Where RGDP refers o real gross domesic produc, PK o physical capial, LF o labor force, HCD o human

4 Inernaional Journal of Ehics in Engineering & Managemen Educaion Websie: (ISSN: , Volume 2, Issue 5, May 2015) capial developmen, CPI o consumer price index, M 2 o broad money supply, OPP o openness, REER o real effecive exchange rae, DD, is dummy o drough µ o denoes he sochasic error erm and subscrip refers o ime. All variables are in log form. Daa ype and source The sudy use annual ime series secondary daa covering he period from 1974/75 o 2011/12 and colleced from differen sources. The poenial caveas ha hinder he success of his sudy include lack of adequae daa, daa aggregaion, ime and financial consrains and he like. The absence of quarerly daa on some macroeconomic variables like real GDP and governmen spending in Ehiopia has forced he presen sudy o rely on annual. The major daa sources for he problem under invesigaion are shown in able 1 below. Table 1: Sources of daa and measuremen beween he wo as he Ehiopian economy is agrarian and increase oupu means high food supply and his in urn reduces prices of food iems, which accoun 57% of consumer price index. However, he rend analysis in figure 1 indicaes inconclusive picures abou heir relaion for he period 1974/75 o 2009/10.I depics almos an inverse relaionship in he earlier period. Besides, as can be seen from figure 1 and annex 1, high inflaion was occurred a he ime of low economic growh when he economy was affeced by drough and war (for insance, drough in 1985/86 and war in 1991/92). However, in he laer period, beween 1993/94 and 2009/10, he rends of inflaion and economic growh have reversed and showed posiive relaion. Tha is, boh high inflaion and high economic growh appear ogeher. Figure 1: Trends of inflaion, real GDP and broad money (M2) growh rae Trend Analysis Inflaion and economic growh The rend of inflaion shows he change in he inflaion over he sudy period. Looking a he rends of inflaion would enable us o undersand he change of inflaion during he sudy period over he years. Furher i observes wha goes wrong or righ a a paricular year. The rend analysis in figure 1 below indicaes ha he counry has been experiencing he higher price rise since 2003/2004. In 2001/02, he inflaion rae was negaive -8.2 percen. In 2003/04, he inflaion rae increased o 17.7 percen. Bu he recovery of he agriculural producion and he general economic growh has reduced he inflaion rae o 3.2 percen in 2004/05. Afer 2004/05, he inflaion rae could no show any sign of declining ill 2008/09. In 2008/09, he inflaion reached is highes 44.3 percen. Source: Own compuaion based on MoFED and NBE daa, 2010 Esimaion Procedure and Resuls Uni roo es In ime series analysis, he firs sep is examining he saionariy of he daa used in he regression analysis. There are several ways of esing for he presence of uni roo. The mos common and popular one in economeric work is he Dickey-Fuller (DF) es due o Dickey and Fuller (1979, 1981) eiher because of is simpliciy or is more general naure (Maddala, 1992; Gujarai, 2003). Therefore, o perform he saionariy es for he variable included in he model, he convenional Dickey-Fuller (DF) and Augmened Dickey Fuller (ADF) ess are used. The es resuls reveal ha all variables are found o be non-saionary. However, he es applied o he same variables afer firs difference become saionary a he convenional 5% level of significance (see annex 1). I means ha, all he series are inegraed of order (1). Table 2 However, comparing Ehiopia s inflaion agains he growh rae of real GDP, one may expec a negaive relaionship 4

5 Inernaional Journal of Ehics in Engineering & Managemen Educaion Websie: (ISSN: , Volume 2, Issue 5, May 2015) Therefore, he series can be esed for he exisence of a longrun relaionship (co inegraion). Correlaion Marix Following a Uni Roo Tes, here is a correlaion marix o deec he correlaion beween RGDP, and CPI. Table 2: Correlaion Marix beween RGDP and CPI The resul finds negaive correlaion exiss beween inflaion and economic growh. This negaive relaionship holds consisen wih radiional classical heory, Sockman s neoclassical model and endogenous growh heories, which imply ha higher inflaion, is negaively correlaed o economic growh. Co inegraion es Afer uni roo ess, he nex sep is o es for he exisence of long erm Coinegraion relaionship among he variables. This is checked using he Johansen s mulivariae es. Thus, using Johansen s approach of coinegraion wih one lag for boh growh and inflaion model, which is deermined by Akaike Informaion Crierion (AIC), Schwarz Informaion Crierion (SIC), and Hannan-Quinn Informaion Crierion (HQIC) wih he lowes in AIQ, SIC and HQIC in absolue value is he mos efficien one (see able 3 below) indicaes ha here is one coinegraion relaionship beween variables based on boh race and maximum eigenvalue ess. alernaive hypohesis of one coinegraion vecor (r= 0+ 1) is rejeced since he es saisic (70.992) is greaer han he 95 percen criical value (57.1). DISCUSSION OF ESTIMATION RESULTS Long-run esimaion resuls Before formulaing he long run model he significance es on he long run parameers are underaken. Accordingly, a zeroresricion is imposed on each β coefficiens and he resul of he es along wih heir respecive probabiliy values are repored on annex. Hence, he long run growh equaion wih heir respecive significance es is presened as follows Where * and **denoes rejecion of he null hypohesis a 1% and 5% level of significance respecively. A value in parenhesis indicaes he es of significance. The resul implies ha labor force and physical capial developmen play he main role in increasing economic growh in Ehiopia ogeher wih good weaher condiion (rainfall). For insance, a one percen increases in physical capial and labor force developmen leads o 0.37 and 0.29 percen increase in economic growh respecively. On he oher hand, he posiive and significan coefficien of real effecive exchange rae revels ha devaluaion affecs economic growh negaively hrough increasing he cos of producion of impored iems. Table 4: Johansen es resuls for number of coinegraing As can be seen from able 4 above, he race es indicaes ha he null hypohesis ha here is no coinegraion ( r = 0) agains he alernaive ( r = 1) is rejeced, because, he race Saisic- λ race (220) is greaer han he 95 percen criical value (193). Bu, he null hypohesis of one co-inegraion vecor is no rejeced since he race Saisic- λ race (149.1) less han he 95 percen criical value (124.2). Similarly, maximum eigenvalue es indicaes ha he null hypohesis ha here is no coinegraion vecor(r=0) agains he Openness proxy by he volume of rade as percenage of RGDP has insignifican impac owards economic growh. This seemingly conradicory resul can be jusified by he basic idea ha in less developed counries impor akes he lion share of he rade volume. These imporable iems are mainly of consumable goods, which have no significan relaionship wih invesmen and ulimaely economic growh, and his offses he posiive effec of openness hrough ransfer of knowledge and impor of capial goods for producion in he long run. Moreover, he resul of our concern variable inflaion indicaes he insignifican effec on economic growh, which suppors ha he Mundell-Tobin effec of inflaion on oupu growh hrough increasing capial accumulaion offse by Sockman effec ha says ha inflaion reduces economic growh by increasing cos of invesmen. This resul is in line wih he findings of Faria and Carneiro (2001). The Shor-run dynamic (error correcion) model The shor run dynamics of he growh model is esimaed using he general o specific modeling approach of OLS echniques like ha of he inflaion model as explained above. 5

6 Inernaional Journal of Ehics in Engineering & Managemen Educaion Websie: (ISSN: , Volume 2, Issue 5, May 2015) On he oher hand, domesic money supply and drough affec oupu growh in Ehiopia negaively and significanly in he shor run. The negaive effec of money on economic growh in he shor run is by increasing inflaion, which resuls in uncerainy in he economy. Moreover, he coefficien of error correcion erm (ECM-1), which indicaes he rae a which oupu growh adjus o shocks in he sysem, has a negaive sign as expeced and saisically significan a 1% level of significance. Granger Causaliy Tes beween RGDP and Inflaion Granger causaliy es provides imporan informaion of he causal direcion beween he variables and knowing he direcion of causaliy helps for long-run and shor run analysis beween he variables. Table 6: Pair wise Granger Causaliy Tess As shown in he above able he various diagnosic ess showed ha he model is correcly specified. As indicaed above he es summary reveals ha here is no problem of error erm auocorrelaion. Tha is he es does no rejec he null hypohesis of no error erm auocorrelaion (AR1-2). The es for auoregressive condiional heeroscedasiciy (ARCH) failure o rejec he null of no ARCH indicaes he exisence of consan variance. The es for normaliy canno rejec he null hypohesis of normaliy and indicaes ha he error erm is normally disribued. Finally, he RESET (regression specificaion es) does no rejec he null hypohesis of no funcional misspecificaion in he esimaed equaions and i reveals ha here is no problem of model misspecificaion As in our long run model, he coefficien of he shor run model shows he shor run elasiciy of he variable wih respec o he oupu growh. The coefficien of he firs lag of he change in he consumer price index (DLCPI_1) is negaive and saisically significan implying ha inflaion negaively affecs oupu growh in Ehiopia. Tha is higher rae of inflaion reduces oupu growh and suppors he Sockman s effec. Differenly, eiher i ouweighs he Mundell-Tobin effec, or i conribues o increased macroeconomic uncerainy, which, in urn, negaively affecs economic aciviy and consequenly economic growh. This finding is in line wih findings of Barro (1995), Khan and Senhadji (2000), Gokal and Hanif (2004), Ahmed and Moraza (2005), Seleeng (2004), Sergii (2009), Beencour (2010), Salian and Gopakkumar (2009), and Mubarik (2005). Moreover, he one period lag of RGDP has a posiive and significan effec on he curren change in real GDP growh a 1 percen level of significance. Specifically, a 1% change in real GDP las year will lead o a 0.8% change in real GDP growh in he curren period. A 1% change in labor force and physical capial will lead o 0.12% and 0.06% increases in oupu growh in he shor run respecively. Moreover, real exchange rae and openness have also posiive and significan effecs on oupu growh in he shor run a 1 percen level of significance. The above able shows ha boh he hypohesis ha economic growh does no Granger Cause inflaion and inflaion does no Granger Cause economic growh is rejeced significanly a 5% significance level. This means ha here is a bi-causal direcion beween inflaion and economic growh in Ehiopia. For Ehiopia, sabilizing price by reducing CPI will lead o higher economic growh and fas economic growh will reduce inflaion. Esimaion of Threshold level of Inflaion The esimaed resuls sugges ha for low inflaion levels (k < 9) here is an insignifican relaionship beween economic growh and inflaion. For higher inflaion level (k > 10) here is a significan negaive relaionship beween economic growh and inflaion. Finally, 9-10 percen inflaion level is a hreshold level, which is obained by finding ha value of k ha maximizes he value of R 2 and Minimize he value RSS. CONCLUSIONS AND POLICY IMPLICATION Conclusion One of he main objecives of macroeconomic policy of he Ehiopia economy is o aain susainable economic growh ogeher wih sable price level. However, in recen imes he counry has been experiencing an increasing price level and he siuaion has go wide range of concern regarding is effec on economic growh. Hence, he cenral focus of his sudy is o idenify he naure of inflaion-economic growh relaionship of Ehiopia from 1974/75 o 2011/12, specifically by using he framework of VAR, vecor error correcion mechanism using annual daa covering he period from 1974/75 o 2009/10. All he variables are esed for uni roos using ADF es and he es resul revealed he variables are saionary a heir firs difference. The resul of coinegraion 6

7 Inernaional Journal of Ehics in Engineering & Managemen Educaion Websie: (ISSN: , Volume 2, Issue 5, May 2015) es, using Johansen Maximum likelihood approach, indicaes he exisence of long run relaionship among he variables enered in he models. The descripive analysis indicaes he rend of inflaion and growh. Inflaion rae ends o be high when he growh performance of he economy is weak and i falls when he counry recorded high growh rae in he earlier ime of he sudy. However, his link seems o have been los since 2003/04 on wards as boh are coninuously increasing. Since underaking a descripive analysis canno help o fully address he objecives of he sudy, he sudy uses ime series economeric analysis o complemen he descripive one. From he esimaed VAR model he shor run resul indicaes ha an increase in inflaion reduces economic growh in he shor run. The long run resul of he sudy has shown ha he effec of inflaion is insignifican which reflecs ha he Mundell-Tobin effec of inflaion on economic growh is offse by he Sockman effec in he long run. The Granger Causaliy Tes found he bidirecional causal relaionship beween inflaion and economic growh. Moreover, i is believed ha low and sable inflaion promoes economic growh and vice versa. And his hreshold level of inflaion depends on he naure and srucure of he economy and varies across counries. Based on he model developed by Khan and Senhadji (2001) he hreshold level of inflaion is compued. The hreshold model esimaion recommends 9-10 percen hreshold inflaion level, which is opimal for economic growh. Above his level inflaion affecs economic growh negaively. Recommendaions Based on he analysis made and he major findings obained he sudy ries o forward he following policy recommendaions; The long-run negaive bi-direcion causal relaionship beween inflaion and economic growh sugges ha he counry should conrol he level of inflaion in order o uphold higher economic growh. The resul migh be useful for policymakers in providing some indicaion in seing an opimal inflaion arge. Policymakers should no exer effors o keep he inflaion rae a low-level percen since inflaion below he hreshold level (9-10%) does no hamper economic performance. Therefore, conrolling moderae inflaion should be he main goal for policymakers in Ehiopia. Here he auhors of his research paper have creaed and conribued a lile bi amoun of research for he hinkers, believers and policy makers of he counry. No only for he Ehiopian bu all developing counries may ake his research as an epiome of conrolling and susaining he inflaion of heir own counries. 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