Inflation Dynamics and Macroeconomic Stability in Ethiopia: Decomposition Approach

This study was driven by the fact that inflation has become one of the binding constraints for policy makers both in their short- and long-term efforts to advance economic progress. There is a growing need to examine the commodity wise contributions and drivers of inflation, and to decompose it into its permanent and transitory components. So, the objectives of this study are first, to investigate the evolution and dynamics of inflation by decomposing the headline inflation (raw inflation) into its core (permanent) and transitory (non-permanent) components from highly disaggregated commodities’ prices. Secondly, it aims to investigate the association between core inflation (the predictor of headline inflation) and macroeconomic stability. To summarize the policy implication: There is a need for managing domestic and external disequilibria. Key domestic disequilibria include fiscal deficits and imbalances between domestic saving and aggregate investment demand. Managing the external disequilibria would mean management of external debt as one of the binding constraints for achieving macroeconomic stability.