Graduate Program

Economics

Degree Name

Master of Arts (MA)

Semester of Degree Completion

2007

Thesis Director

Mukti Upadhyay

Thesis Committee Member

Hui Li

Thesis Committee Member

Eric Hake

Abstract

This paper examines the role of exchange rates in determining the trade balance and output behavior for Ethiopia. Conventional wisdom says that a real devaluation improves the trade balance and has an expansionary impact on output. Empirically, the evidence for both developed and developing countries has been inconsistent in either rejecting or supporting this hypothesis. This paper attempts to find evidence for these conditions. It uses a regression model formulation which includes income and money so that the monetary and absorption approaches to the balance of payments are also examined. The econometric procedure used is the Engle-Granger two-step method to test for cointegration. The main result is that exchange rates do play a role in determining the behavior of the trade balance in Ethiopia. Moreover, depreciation of the currency also has an expansionary impact on output. The results show that the long-run effect of exchange rate devaluation on output is enhanced if accompanied by increase in the money stock and in income. The findings with respect to income and money variables did not uniformly reject or accept hypotheses from the absorption or monetary approaches.

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