The effect of interest rates on saving and investment in ethiopia

The objective of this paper will be to assess the effect of interest rates on saving and investment in Ethiopia. The nature and sources of data for this research is secondary data sources. The secondary data source is through the annual reports of the National Bank of Ethiopia (NBE) from 1986 – 2015 G.C Based on Vector Auto Regressive (VAR) model. Co-integration and vector error correction model tests are applied to assess the short and long run relationship among the variables. On this study saving (gross domestic saving) and investment (capital formation) has been used as the dependent variable and interest rates (deposit rate and lending rate) as independent variable. A stationarity test was carried out using Graphical approach and Augmented Dickey Fuller (ADF) test. Stationarity is found at first difference at 5% level of significance. The Johnson co-integration test showed that, there was long run co-integrating relationship between the variables. Based on the result interest rates have significant effect on saving and investment in Ethiopia. Moreover the result reveals that the coefficient of error correction term or the speed of adjustment term for the estimated interest rates equation is statistically significant and negative. It implies that the model is efficient. The coefficient term is -1.15 shows that 115% adjustment will be taken in a year to converge to the long run equilibrium level. So in order to reach along run equilibrium the model takes only eleven month.