Economic Study Spotlights Dark Side Of Central Bank’s Credit Cap Regime

‘The negative impact of credit ceilings outweigh the intended benefits.’

The National Bank of Ethiopia’s (NBE) two-and-a-half year experiment with capping credit growth at commercial banks has had minimal results in taming inflation, but disproportionate and largely negative impacts on investment and economic output, argues a research paper published by Ethiopian economists.

Dubbed ‘Credit-Growth Ceilings and Macroeconomic Effects in Ethiopia: Initial Observations,’ the study was conducted by Tadele Ferede, associate professor at Addis Ababa University (AAU) and former president of the Ethiopian Economics Association, in collaboration with Yetsedaw Emagne, research fellow at the Policy Innovation Research Center.

The central bank first introduced the credit expansion ceiling under the tenure of Governor Mamo Mihretu in August 2023, setting it at 14 percent in a bid to control a headline inflation rate that sat above 30 percent.

Since then, the ceiling has been revised to 18 percent and, most recently, to 24 percent, reflecting the authorities’ attempt to strike a balance between price stability and economic recovery.

However, economists Tadele and Yetsedaw argue that despite intense policy debate, empirical and model-based evidence on the transmission of credit ceilings within the Ethiopian economy remains limited.

Their effects on output, investment, inflation, credit dynamics, and macroeconomic volatility are not well understood, according to the paper.

“The magnitude of these effects suggests that credit caps contribute only marginally to inflation containment. Moreover, the inflation response is short-lived, as the economy adjusts to lower levels of activity. This pattern is consistent with demand-driven disinflation rather than a sustained improvement in underlying price stability or inflation expectations,” it reads.

The experts conclude that in the absence of complementary monetary or structural measures, the credit ceiling does not generate persistent disinflation, and argue the cap entails significant policy trade-offs.

“Tighter credit ceilings can alleviate demand pressures and support short-term inflation containment, but they do so at the cost of slower and more volatile real economic activity. The macroeconomic costs of credit growth caps are transmitted primarily through reduced investment and weaker aggregate demand, with spillovers to output and a contraction in medium-term growth. This highlights a clear stabilization dilemma,” reads the paper.

The authors urge regulators to carefully calibrate credit-growth ceilings and complement them with targeted interventions to support productive investment and consumption.

“Overall, the findings imply that Ethiopia’s credit-cap policy delivers lower inflation and short-term relief to the balance of payments but at the cost of reduced economic dynamism and slower capital accumulation. The policy challenge, therefore, is not whether to use credit caps, but how to calibrate them carefully, gradually ease them as inflation declines, and combine them with broader reforms that expand productive credit, deepen financial intermediation, and strengthen the monetary policy framework,” reads the paper.

The authors explain that credit ceilings can deliver short-term external adjustment at the cost of weakening the supply side of the economy.

“Borrowing constraints restrict households’ ability to finance spending, especially on durable goods while firms cut back on investment when access to finance becomes limited. Consumption declines due to tighter household credit conditions, while investment falls more sharply,” reads the paper.

It forwards a number of recommendations, including reduced reliance on administrative credit caps that distort lending allocation and restrict access to finance, particularly for productive sectors critical to growth.

“It is recommended that credit caps be used as a temporary and complementary policy instrument, rather than as a primary tool for macroeconomic stabilization,” reads the paper.