The move is designed to allow political dialogue.
Ethiopia's prime minister Hailemariam Desalegn told a press conference charges would also be dropped for those still awaiting trial.
Ethiopia is accused by human rights groups of using mass arrests and detention to stifle opposition.
It is unclear exactly what prompted the decision, which came after days of consultations within the ruling coalition, the Ethiopian People's Revolutionary Democratic Front (EPRDF).
Ethiopia's prime minister has announced the release all political prisoners and the closure of a notorious detention centre which allegedly used torture to extract confessions.
Hailemariam Desalegn told a press conference charges would also be dropped for those still awaiting trial.
The move is designed to allow political dialogue, he said.
Ethiopia is accused by human rights groups of using mass arrests and detention to stifle opposition.
State of emergency
The country declared a state of emergency in 2016, following a year of protest calling for political and economic reforms, which prompted a crackdown.
Mr Hailemariam's announcement included the closure of Maekelawi - a detention facility at the centre of the torture allegations, which have been denied by the government.
According to Ethiopian newspaper the Addis Standard, the prison will become a "modern museum".
A new detention centre will be opened, Mr Hailemariam said, which would comply with international standards.
It is unclear exactly what prompted the decisions, which came after days of consultations within the ruling coalition, the Ethiopian People's Revolutionary Democratic Front (EPRDF).
However, the Addis Standard links it to two days of action across social media at the end of December, raising awareness of the plight of political prisoners.