Impact of Domestic Credit Shock on Output and Price in Ethiopia

Financial Economics, Macroeconomic Policy, Money and Banking

Using the Structural Vector Autoregression (SVAR) method, this paper analyses the impact of domestic credit shock on Ethiopian economy for the period 1998 to 2013 using quarterly data. Totally six variables are included in this SVAR model, four from domestic economy and two from external economy. A number of restrictions were imposed on the contemporaneous relationship of variables to identify the unique dynamic response of inflation and output to the credit innovations. The impulse response shows that positive credit shock affect CPI positively for long period of time (about five year)and affect real GDP negatively at the beginning (output puzzle) and then positively after third quarter. Whereas, variance decomposition found that the own innovation of domestic variables, except domestic credit, has the highest proportion both in short-term and long-term forecast error. Innovations of CPI take the highest proportion in explaining forecast error of domestic credit relative to other endogenous variables. Based on the finding of the study it can be suggested that taking into account the relative impact of credit shock on output and price monetary policy can stimulate output and stabilize price through instruments that affect credit of banking system.

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