New research conducted by CEPHEUS Growth Capital Partners hints that the recent inflation spike of Ethiopia has been affected by the faster grows of money supply than the economic outputs.

While Ethiopia tends to experience periodic episodes of inflation, such as in mid-2015 and mid-2018, the current episode stands out for reaching near decade-long highs, especially since the start of the conflict in Nov 2020, stated the latest CEPHEUS research output.

Here, we excerpt some points of the study regarding money supply and inflation as follows.

Based on the study, monetary policy has very generously accommodated the government’s need for substantially higher domestic borrowing this year, and net credit to the Government—especially from the central bank—has thus grown at rates not seen in many years. While the Government’s ability to cover its deficit from mainly domestic sources is positive, two major casualties with this policy approach are seen with: (1) the drop in growth of credit to the private sector; and (2) the spike in inflation.

Money supply was up 30 percent for the 2020/21 fiscal year (from Birr 1,038bn to Birr 1,348bn) and is still showing high growth, of 28 percent year-on-year, as of September 2021.

Reflecting the above, net domestic credit to government (as of September 2021) was up 94 percent from year ago levels and is showing the highest growth rates in over a decade. NBE, commercial banks, and pension funds have stepped in to cover the jump in government borrowing.

The study further revealed that inflation for food item reached the highest levels in the last fiscal year. This directly go along with the fact that people in developing economies spend a greater share of their budget on food items than any other economic activities.

The national level inflation has characterized by a strong dominance of food rather than non-food items and the larger role of goods rather than services.  

Strong monetary growth appears to be contributing to inflation, even if it is certainly not the sole culprit: An analysis of the main components of inflation suggests that multiple factors—beyond just monetary policy—are having a contribution, including supply-side disruptions to food markets, transport bottlenecks, rising global commodity prices, and a strongly depreciating exchange rate.

The recent increase in inflation has moved closely with growth in money supply, especially since mid-2020; however, despite the positive correlations, the longer-term relationship is not very tight or consistent. For example, the five relatively low inflation years between 2013 and 2017 showed mostly single-digit inflation despite the fact that money supply growth in those years was relatively elevated at around 25-30 percent

Cepheus study explores the relationship more formally using 10 years of quarterly data suggests a modest but not very strong relationship between monetary growth and inflation

From a cross-country context, Ethiopia’s experience also stands out, especially among other Sub-Saharan African countries facing a similar global environment. Inflation is low and declining, on average, for most of SSA compared to an upward trend in Ethiopia.

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