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American Journal of  Applied 
Statistics and Economics (AJASE)

Review on:  Effect of  Inflation on Economic Growth in Ethiopia
Tadele Anagaw1*

Volume 2 Issue 1, Year 2023
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Article Information ABSTRACT

Received: April 12, 2023

Accepted: May 03, 2023

Published: May 17, 2023

One of  the main objectives of  macroeconomic policy of  most developing countries like 
Ethiopia is to attain sustainable economic growth together with stable price level. Price 
stability is considered as a proxy for macroeconomic stability, the ongoing high level of  
inflation is not a good sign. Large fluctuations in inflation for firms, consumers and the 
public sector reduce the economy in the long run growth potential. The nations of  the 
countries who are highly affected by the problem of  inflation are those who have low level 
of  income or fixed income and unemployed portion of  the population. Higher average 
inflation has a negative impact on the steady state growth. This is because of  the higher 
cost of  transaction that inflation causes to the money market. It is generally accepted that 
instability in the general level of  prices causes substantial economic distortions, leading 
to inefficiencies, both in aggregate employment and output. Due to different factors, the 
effects of  inflation have significant effect on economic growth in Ethiopia. 

Keywords

Economic Growth, Inflation, 
Ethiopia 

1 Department of  Agricultural Economics, Salale University, Fitche, Ethiopia
* Corresponding author’s e-mail: tadeleanagaw21@gmail.com

INTRODUCTION
World economic growth and inflation rates have been 
fluctuating. Likewise, inflation rates have been dominating 
to compare with growth rates in virtually many years 
and relationship between inflation and the economic 
growth continued to be one of  the most macroeconomic 
problems (Madhukar and Nagarjuna, 2011). One of  
the central macroeconomic policy objectives of  most 
developing countries in the world is maintaining price 
stability together with economic growth. Ethiopia is one 
of  the countries in Sub Saharan African with moderate 
economic growth in recent years. The country’s economic 
progress is accompanied by sustained inflationary 
problems. Inflation’s effects on an economy are various 
and can be simultaneously positive and negative in 
Ethiopia (Umaru and Zubairu, 2012). According to 
Abdurahman Mohammed’s report, Ethiopia’s inflation 
rate remains persistently high, reaching 33.6 percent in 
February 2022. The renewed conflict in the north and 
the most prolonged and severe droughts in recent years 
were the main reasons behind the high inflation, given 
the adverse impact on economic growth. A high or 
unpredictable inflation rate are regarded as harmful to 
an overall economy that add inefficiency in the market, 
and makes it difficult for companies to plan long term 
(Mankiw, N.Gregory, 2002). 

Objective of  the Review 
To review the effect of  inflation on economic growth in 
Ethiopia.

Overview of  Inflation and Economic Growth in 
Ethiopia
Inflation is defined as the general rise in the price level of  
goods and services in the given economy. General rise in 

the price level indicates the net change in the price of  all 
baskets of  commodity produced and services provided 
in the economy. That means there may be an increase or 
decrease in the price of  basket of  some commodity in the 
economy. The net effect gives us the general rise in the 
price level or decrease in the price level. If  the net change 
is a rise in the price level, we can call it inflation otherwise 
deflation (Teshome, 2011). It measures the change in 
average price level on a year on year basis-that is:
                                                 
                                                   where: t is a particular 
year in time; and t-1 is the year before (Gillepie, 2011).
Economic growth is the increase in the amount of  goods 
and services produced by the economy overtime (Solow, 
1995). It can be measured in real or nominal terms. Real 
terms have been adjusted for inflation and nominal terms 
are not adjusted for inflation. Economic growth is usually 
measured as the percentage rate of  increase in real GDP 
(Swan, 1997). On the other hand, economic growth is 
a sustained increase in per capita national output or net 
national product over a long period of  time. (Dwivedi, 
2004).

Theories on Economic Growth and Inflation 
Economists have been studying about inflation and its 
effect on economic growth starting from the appearance 
of  classical economic theory to modern economic theories. 
The following table summarizes the statement of  different 
theories on about inflation and economic growth.

The Effect of  Inflation on Economic Growth in 
Ethiopia
Inflation’s effects on an economy are various and can 
be simultaneously positive and negative. Inflation causes 
individuals to substitute out of  money and into interest 

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Am. J. Appl. Stat. Econ. 2(1) 7-10, 2023

Table 1:  Theories on Inflation and Economic Growth
No Theories Their statement on inflation 

1 Classical theory There is no direct explanation between inflation and its tax effect on profit level & output. 
But the relationship between the two variables is implicitly negative by the reduction in 
firms’ profit level and saving through higher wage costs (Gokal and Hanif, 2004).

2 Keynesian theory Excess demand is the major cause for the existence of  inflation (Gokal V. and Hanif  S, 
2004).

3 Monetary theory Inflation occurs when money supply rises faster than the rate of  economic growth of  
national income (Richard Froyen, 1998).

4 Neo classical 
growth theory

Inflation increases output growth rate by stimulating capital accumulation, because in 
response to inflation households would hold less in money balance and more in other 
asset (Mudell, 1963).

Table 2:  Source of  Inflation 
No Source of  inflation 

1 Demand Pull 
Inflation

It occurs when aggregated demand exceeds aggregate supply. This excess demand may 
occur due to increase in one or all components of  aggregate demand which includes 
consumption, investment, government expenditure and net exports. The excess 
demand creates disequilibrium and pulls up prices until equilibrium is restored. This 
is because the increase in aggregate demand causes shortage of  goods and services at 
old prices.  This in turn leads to price increases until equilibrium is restored (Campbell 
R and L.Stanley, 1986).

2 Cost Push Inflation It is a situation occurs when there is caused by an increase of  one or more of  the cost 
or supply side factors such as the rising wages, input price (domestic or imported), 
interest rate, taxes, and exchange rate (Campbell R and L.Stanley, 1986).

              Current Causes of  Inflation in Ethiopia
1 Outbreak of  

COVID-19
The impact of  COVID 19 pandemic uncertainty shock on the macroeconomic 
stability in Ethiopia in the short run period.

2 Civil war Ethiopia was embroiled in spiraling & soaring ethnic and a state-based large-scale 
armed conflict that has continued for more than a year.

earning assets, which leads to greater capital intensity and 
promotes economic growth. In effect, inflation exhibits 
a positive relationship to economic growth. Inflation 
initially motivates capital accumulation which will 
contribute to higher growth. But the effect of  inflation 
on growth is only temporary since this works only until 
the return on capital falls (Tobin, 1965). High inflation 
increases the opportunity cost of  holding cash balance 
and can induce people to hold greater portion of  their 
assets in interest paying accounts. With high inflation, 
firms must change their prices often in order to keep 
up with economy. It can benefit the inflators (those 
responsible for the inflation) and it benefits early and first 
recipients of  the inflated money. It can also benefits big 
cartels, destroys small sellers, and can use price control 
set by the cartels for their own benefits. (Mankiw, N, 
2002). Optimal inflation ranging from 2–3% is good 
for economic growth. It increases the employment 
opportunities in the countries, increases the economic 
activities, and encourages investment and production by 
raising the rate of  profit (Fischer, 1993).
Unpredictable inflation rate are regarded as harmful to 
an overall economy they add in efficiency in the market, 
and makes it difficult for companies to plan long term 

and also that inflation distorts price mechanism, and 
this will affect the efficiency of  resource’s allocation and 
hence influence economic growth negatively (Fischer, 
1993). It can impose hidden tax increases as inflated 
earnings push tax payers in to higher income. With high 
inflation, purchasing power is redistributed from those 
on fixed nominal income. It also makes traders from an 
increased instability in currency exchange price caused by 
unpredictable inflation (Mankiw, N, 2002).  Inflation and 
economic growth entitled that the channel through which 
inflation affect economic growth and inflation negatively 
affects growth by reducing investment, and by reducing 
rate of  productivity growth (Fikirte, T, 2012). 
High inflation can cause serious problems on the economic 
growth. It would bring a large distribution of  income. 
Higher food price would hurt the urban poor who spend 
most of  their income on food. Moreover, although it would 
have a positive effect on the rural food producers, it would 
have an adverse effect on the rural food buyers, which may 
consist of  about half  of  population in the rural Ethiopia. 
Thus, higher inflation, particularly through higher food 
price, could worsen the economic inequality. High inflation 
would also increase of  uncertainty about future inflation 
(Conrad and Karanasos, 2004). 

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Am. J. Appl. Stat. Econ. 2(1) 7-10, 2023

Inflation can cause a number of  problems for an 
economy. It may damage business confidence because 
of  fears about the future impact on costs. This may 
reduce levels of  investment. Uncertainty about future 
inflation rates will make it difficult to estimate future 
profits and   therefore may deter many projects, damaging 
economic growth; if  prices are increasing this creates 
costs for firms, because they may have to update their 
promotional material to list the higher prices; it erodes 
the purchasing power of  individuals’ earnings.  If  wages 
do not increase as much as prices, then, in real terms, 
wage earners are worse off.  Their real income has fallen; 
if  the prices of  firms in Ethiopia are increasing faster 
than those of  their trading partners, then this may make 
the Ethiopian products uncompetitive compared to those 
of  foreign firms; Tax thresholds often do not increase 
in line with inflation. If  employees gain a wage increase 

to match inflation, then they are not better off  in real 
terms. However, with higher nominal wage, individuals 
may enter a higher tax bracket and therefore be worse 
off. This is called bracket creep. And also redistributes 
income from one individual to another. Debtors benefit 
during inflation moments at the expense of  creditors 
and the government gains at the expense of  the private 
sector; and Inflation creates inflation expectations and 
it actually feeds on these expectations. It is often said 
that the greatest cost of  inflation is the one inflation 
causes itself. The effects of  inflation will depend partly 
on whether it is anticipated or unanticipated inflation. If  
inflation levels are regularly unanticipated, then this will 
lead to high levels of  uncertainty in the economy, which 
may deter investment and affect spending, and impact 
saving decisions (Arnold, 2008).

Table 3: Summary of  Effect of  Inflation on Economic Growth in Ethiopia 

No Author/s, Year of  publication Effect of  Inflation on Economic Growth in Ethiopia 
1 Barro (1995) It reduces the level of  investment and a reduction in investment 

adversely affects economic growth of  the country due to sharp increase 
in the cost of  their investment projects.

2 Dotsey and Sarte (2000) Higher average inflation has a negative impact on the steady state 
growth. This is because of  the higher cost of  transaction that inflation 
causes to the money market.

3 Bruno and Easterly (1996) A higher level of  inflation harms the growth and lower inflation has 
less cost on the economy.

4 Fisher (1993) Inflation negatively affects growth by reducing investment, and by 
reducing rate of  productivity growth. Fisher also argues that inflation 
distorts price mechanism, and this will affect the efficiency of  
resource's allocation and hence influence economic growth negatively. 
He argued that inflation hampers the efficient allocation of  resources 
due to harmful changes of  relative prices.

5 Conrad and Karanasos, (2004) High inflation can cause serious problems on the economic growth. 
It would bring a large distribution of  income. Higher food price 
would hurt the urban poor who spend most of  their income on food. 
Moreover, although it would have a positive effect on the rural food 
producers, it would have an adverse effect on the rural food buyers, 
which may consist of  about half  of  population in the rural Ethiopia. 
Thus, higher inflation, particularly through higher food price, could 
worsen the economic inequality. 

6 Fikirte, T, (2012) Inflation and economic growth entitled that the channel through which 
inflation affect economic growth and inflation negatively affects growth 
by reducing investment, and by reducing rate of  productivity growth. 

7 Arnold, (2008) If  inflation levels are regularly unanticipated, then this will lead to high 
levels of  uncertainty in the economy, which may deter investment and 
affect spending, and impact saving decisions. 

CONCLUSION
One of  the main objectives of  macroeconomic policy 
of  this country is to attain sustainable economic 
growth together with stable price level. As known, day 
to day increment of  price of  goods and services is a 
key problem of  economic backwardness in Ethiopia. 
Sustained inflation has harmful effects on societal welfare 

and income inequality in such a way that the income 
distribution tends to be skewed and also decrease in the 
real value of  money and other monetary items overtime, 
uncertainty over future inflation may discourage 
investment and savings, and high inflation leads to 
shortages of  goods if  consumers begin hoarding out of  
concern that prices will increases in the future. Therefore, 

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Am. J. Appl. Stat. Econ. 2(1) 7-10, 2023

to overcome this inflation problem on economic growth 
of  the country, focus should be given on policies that 
will achieve price stability in the country, firms should 
produce more production to satisfy consumers and to 
reduce inflation, peoples who have low income should 
increase their income and reduce inflation by reorganizing 
their production system, e.g. using technology.

REFERENCES
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Ethiopia despite Policy Measures to Stabilize Prices. 
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Arnold, R. (2008). Economics, 8th Edition. California: 
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Barro, Robert J. (1995). Inflation and Economic Growth. 
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Bruno, M. and Easterly, W. (1996). Inflation and Growth: 
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Campbell R. and Brue, L. (1986).  Contemporary Labor 
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Conrad, C. and Karanasos, M. (2004). On the inflation-
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Dotsey, M. and Sarte, P. (2000). Inflation Uncertainty and 
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Madhukar, S. and Nagarjuna, B. (2011). Inflation and 
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