Dynamics of trade and technology shocks in Ethiopia: a dynamic stochastic general equilibrium

Trade and technology shocks often drive macroeconomic fluctuations in small, open developing economies; however, the mechanisms underlying their transmission remain poorly understood. This paper employs a small, open-economy dynamic stochastic general equilibrium (DSGE) model using data from 1980 to 2024 to examine how trade and technology shocks propagate through Ethiopia’s economy. The DSGE model consists of endogenous discounting, external borrowing, and capital-adjustment costs. These mechanisms demonstrate how productivity gains from technology can increase returns on factors of production, resulting in higher consumption and investment as agents’ smooth consumption over time. Additionally, the borrowing channel facilitates international capital flows, helping to mitigate the short-term adverse effects of trade shocks. These pathways indicate that positive technology shocks raise output, consumption, investment, and capital by 0.1%–0.2%. Conversely, negative terms-of-trade shocks cause a short-run contraction in output and consumption, as higher import prices reduce real income and shift household spending toward domestic goods. Over time, improved productivity offsets external imbalances, leading to a stronger trade balance and reduced foreign debt. These results confirm asymmetric shock transmission: technology shocks enhance persistent domestic expansion, while trade shocks impose temporary external constraints. This highlights the dominant role of productivity dynamics in shaping Ethiopia’s macroeconomic fluctuations.