The Impact of Monetary Policy on Exchange Market Pressure in Ethiopia

Abstract

This paper examines the effect of monetary policy on exchange market pressure in Ethiopia. The paper employs Girton and Roper (1977) measure of exchange market pressure—sum of exchange rate depreciation and foreign reserves outflow, to examine the interaction between exchange market pressure and monetary variables. Exchange market pressure is measured as the sum of percentage change of international reserves and percentage change of nominal exchange rate. The sum of domestic credit to the private sector and the government sector is used as the measure of monetary policy. Domestic credit is considered the variable directly controlled by policy makers. The response of exchange market pressure due to shock to domestic credit is significant and negative as expected. This implies that the monetary authority in Ethiopia reduces exchange market pressure by either reducing foreign reserves or depreciating domestic currency. In this research, the researcher used detail empirical and theoretical data review as a source of data to show the effect of monetary policy on exchange market pressure. The monetary policy authorities should establish stable economic condition by creating and implementing monetary policies that appreciated economic condition and also create and implement monetary policy to maintain exchange rate stability when appreciated. The government of Ethiopia should not depreciate the exchange rate in the current situation because more than 50% of commodities are imported from abroad which needs dollar.