instruments in Ethiopia, in contrast, are limited to changes in bank reserve requirement and sales/purchases of foreign exchange reserves. In addition, the real exchange rate was allowed to appreciate substantially since 2004<sup>16</sup> , owing to insufficient nominal depreciation in a system of foreign exchange rationing (Figure 4.6).<sup>17</sup> This made the import of expensive public infrastructure equipment relatively cheaper but undermined export competitiveness. The net effect on growth was negative (0.3 ppts in the Late 2000s), though not as substantial as estimated elsewhere. Nevertheless, what stands out from these simulations is that the growth penalty of somewhat less optimal macro policies was not that substantial. High inflation and an overvalued exchange rate cut little over half a percentage point from economic growth rates. This helps explain why Ethiopia was able to grow fast in the presence of some sub-optimal macro policy choices.

Would economic growth have been higher in the absence of heterodox macroeconomic policies? It is hard to give a precise answer to this question. However, it should be pointed out that financial repression, a strong real exchange rate and monetary policy induced inflation all helped support high public infrastructure investment. By providing full access to credit at negative real rates and foreign exchange at below market prices, the cost of public investment was reduced substantially. Moreover, direct central bank financing of the budget deficit and seignorage allowed more public investment to be financed, thus supporting growth. In the presence of more orthodox macro policies, public infrastructure investment would have been lower, which would have lowered growth. The net growth effect of these two alternatives is difficult to estimate with precision, but it is unlikely that that public infrastructure investment could be maintained at similar high levels on the back of orthodox macro policies.

Several other growth drivers, not identified by the model, are also worth consideration. While the model results discussed above are insightful and plausible they, of course, also have some limitations. Ethiopia’s growth was not exclusively driven by public infrastructure investments, restrained government consumption and favorable terms of trade. As discussed in Section 1, productivity growth, factor accumulation, and structural change were also important drivers. Although some productivity gains were infrastructure related, important advances in agricultural productivity arose from improved farming practices and input use, especially fertilizer (World Bank, 2015). Private investment, albeit low, also contributed to capital accumulation. Finally, shifts of labor out of low productivity agriculture and into higher productivity construction and services activities boosted growth.

> 16 The degree of real exchange rate overvaluation fluctuated over time.  World Bank (2013) shows that the real exchange rate of Ethiopia has remained overvalued throughout the 1951-2011 period.  By 2011, the RER overvaluation was 31 percent.  The IMF (2014), using alternative methods and measurement, finds that the real effective exchange rate was overvalued by 10-13 percent in 2014.

> 17 The _de facto_ exchange rate arrangement is classified as a crawl-like arrangement by the IMF (2013b).  The authorities describe it as a managed float with no predetermined path for the exchange rate.  The annual pace of nominal depreciation, however, has been stable at 5 percent in recent years.  The NBE continues to supply foreign exchange to the interbank market based on plans prepared at the beginning of the fiscal year, which take into account estimates of supply and demand.

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