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Optimal Deficit and Debt in the Presence of Foreign Aid

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  • Mayr, Karin

Abstract

Summary External revenue in the form of foreign aid constitutes an important component of the government's budget constraint in many developing countries. We derive optimal public spending--and the resulting optimal deficit and debt--in an optimal control framework when the government seeks to maximize the utility of constituents in the presence of external revenue that cannot be influenced by the government directly but is contingent on public revenue and debt. We find that in this context, a policy of running budget deficits and accumulating debt becomes optimal. In simulations, we characterize the size and the path dependency of the optimal deficit and debt.

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Bibliographic Info

Article provided by Elsevier in its journal World Development.

Volume (Year): 38 (2010)
Issue (Month): 1 (January)
Pages: 19-27

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Handle: RePEc:eee:wdevel:v:38:y:2010:i:1:p:19-27

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Web page: http://www.elsevier.com/locate/worlddev

Related research

Keywords: optimal budget deficits optimal control foreign aid HIPC;

References

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  1. Feeny, Simon, 2007. "Foreign Aid and Fiscal Governance in Melanesia," World Development, Elsevier, vol. 35(3), pages 439-453, March.
  2. Barro, Robert J., 1979. "On the Determination of the Public Debt," Scholarly Articles 3451400, Harvard University Department of Economics.
  3. Franco-Rodriguez, Susana & Morrissey, Oliver & McGillivray, Mark, 1998. "Aid and the Public Sector in Pakistan: Evidence with Endogenous Aid," World Development, Elsevier, vol. 26(7), pages 1241-1250, July.
  4. Cui, Xiaoyong & Gong, Liutang, 2008. "Foreign aid, domestic capital accumulation, and foreign borrowing," Journal of Macroeconomics, Elsevier, vol. 30(3), pages 1269-1284, September.
  5. Liutang Gong & Heng-fu Zou, 1999. "Foreign Aid Reduces Domestic Capital Accumulation and Increases Foreign Borrowing: A Theoretical Analysis," CEMA Working Papers 8, China Economics and Management Academy, Central University of Finance and Economics, revised Apr 2000.
  6. Simon Feeny & Mark McGillivray, 2003. "Aid and public sector borrowing in developing countries," Journal of International Development, John Wiley & Sons, Ltd., vol. 15(8), pages 989-998.
  7. Alberto Alesina & David Dollar, 1998. "Who Gives Foreign Aid to Whom and Why?," NBER Working Papers 6612, National Bureau of Economic Research, Inc.
  8. Kent P. Kimbrough, 1986. "Foreign Aid and Optimal Fiscal Policy," Canadian Journal of Economics, Canadian Economics Association, vol. 19(1), pages 35-61, February.
  9. Mark Aguiar & Gita Gopinath, 2007. "Emerging Market Business Cycles: The Cycle Is the Trend," Journal of Political Economy, University of Chicago Press, vol. 115, pages 69-102.
  10. Easterly, William, 2002. "How Did Heavily Indebted Poor Countries Become Heavily Indebted? Reviewing Two Decades of Debt Relief," World Development, Elsevier, vol. 30(10), pages 1677-1696, October.
  11. Nancy Birdsall & Stijn Claessens & Ishac Diwan, 2002. "Policy Selectivity Foregone: Debt and Donor Behavior in Africa," Working Papers 17, Center for Global Development.
  12. Martin Brownbridge & Emmanuel Tumusiime-Mutebile, 2007. "Aid and Fiscal Deficits: Lessons from Uganda on the Implications for Macroeconomic Management and Fiscal Sustainability," Development Policy Review, Overseas Development Institute, vol. 25(2), pages 193-213, 03.
  13. Peter S. Heller, 2005. "Understanding Fiscal Space," IMF Policy Discussion Papers 05/4, International Monetary Fund.
  14. Ouattara, B., 2006. "Foreign aid and government fiscal behaviour in developing countries: Panel data evidence," Economic Modelling, Elsevier, vol. 23(3), pages 506-514, May.
  15. Susana Franco-Rodriguez, & Mark McGillivray, & Oliver Morrissey, . "Aid and the Public Sector in Pakistan: Evidence with Endogenous Aid," Discussion Papers 98/2, University of Nottingham, CREDIT.
  16. Velasco, Andres, 2000. "Debts and deficits with fragmented fiscal policymaking," Journal of Public Economics, Elsevier, vol. 76(1), pages 105-125, April.
  17. Graham Bird & Alistair Milne, 2003. "Debt Relief for Low Income Countries: Is it Effective and Efficient?," The World Economy, Wiley Blackwell, vol. 26(1), pages 43-59, January.
  18. Heller, Peter S, 1975. "A Model of Public Fiscal Behavior in Developing Countries: Aid, Investment, and Taxation," American Economic Review, American Economic Association, vol. 65(3), pages 429-45, June.
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Cited by:
  1. Bjørnskov, Christian & Schröder, Philipp J.H., 2013. "Are debt repayment incentives undermined by foreign aid?," Journal of Comparative Economics, Elsevier, vol. 41(4), pages 1073-1091.

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