In this study it is tried to uncover the determinants of recent inflationary pressures in Ethiopia. In particular, the study used both simple descriptive analysis as well as rigorous parametric analysis to trace the relationship between inflation and other macroeconomic trends in Ethiopia. From the
analysis the following conclusions (and policy implications) can be drawn. First, fiscal deficit is a key determinant of inflation both in the long run and in short run. This result seems plausible given the fact that government finances significant percentage of the deficit through domestic borrowing from the banking sector. It is also to be noted that government had access to monetary finance through direct borrowing from the National Bank of Ethiopia until recently. This probably also explains how the monetary authorities managed to contain inflation to a target level only after closing this direct lending arrangement. Second, money supply is an important determinant of price dynamics only in the short-run. On the other hand, output remains to be a principal driver of price dynamics in the long run. In particular, we have shown that in the long run inflation rate is more elastic to output than any other variable in the model. This result goes along with the predictions of Ahmed (2007), which puts structural and demand factors at the forefront.
