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Exchange Rate Policy and the Management of Official and Private Capital Flows in Africa

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Author Info

  • Edward Buffie

    (International Monetary Fund)

  • Christopher Adam

    (International Monetary Fund)

  • Stephen O'Connell

    (International Monetary Fund)

  • Catherine Pattillo

    (International Monetary Fund)

Abstract

During the 1990s a number of African central banks succeeded in bringing inflation to relatively low levels while maintaining a market-determined exchange rate. These central banks were generally reluctant to fully subordinate exchange rate targets to monetary targets, however, particularly in the face of large external shocks. We focus on the management of highly persistent shocks to aid flows, including PRSP-related increases in net flows, in the presence of currency substitution by the domestic private sector. Such shocks have beneficent long-run effects, but when currency substitution is high they can produce dramatic macroeconomic management problems in the short run. What is the appropriate mix of money and exchange rate targeting in such cases, and the role of temporary sterilization? We analyze these and related issues in an intertemporal optimizing model that allows a portion of aid to be devoted to reducing the government's seigniorage requirement. This creates a strong link between official aid flows and private capital flows, giving rise to tradeoffs reminiscent of the literature on private capital inflows in emerging markets. When the credibility of policymakers' commitment to low inflation is firm, some degree of dirty floating, with little or no sterilization of increases in the monetary base, is the most attractive approach.

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Bibliographic Info

Article provided by Palgrave Macmillan in its journal Staff Papers - International Monetary Fund.

Volume (Year): 51 (2004)
Issue (Month): s1 (June)
Pages: 126-160

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Handle: RePEc:pal:imfstp:v:51:y:2004:i:s1:p:126-160

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References

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  1. Reinhart, Carmen & Calvo, Guillermo, 2001. "Fixing for your life," MPRA Paper 13873, University Library of Munich, Germany.
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Citations

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Cited by:
  1. Adam, Christopher S. & Buffie, Edward & O'Connell, Stephen & Pattillo, Catherine, 2008. "Monetary Policy Rules for Managing Aid Surges in Africa," Working Paper Series RP2008/77, World Institute for Development Economic Research (UNU-WIDER).
  2. Chance Mwabutwa & Nicola Viegi & Manoel Bittencourt, 2012. "Monetary Policy Response to Capital Inflows in Form of Foreign Aid in Malawi," Working Papers 201232, University of Pretoria, Department of Economics.
  3. Pedro M. G. Martins, 2010. "Aid Absorption and Spending in Africa: A Panel Cointegration Approach," Working Paper Series 1010, Department of Economics, University of Sussex.
  4. Sanusi, Aliyu Rafindadi, 2010. "Exchange rate pass-through to consumer prices in Ghana: Evidence from structural vector auto-regression," MPRA Paper 29491, University Library of Munich, Germany.
  5. Pedro M G Martins, . "Aid Absorption and Spending in Africa: A Panel Cointegration Approach," Discussion Papers 10/06, University of Nottingham, CREDIT.
  6. John Weeks, 2008. "The Reduction of Fiscal Space in Zambia?Dutch Disease and Tight-Money Conditionalities," Country Study 14, International Policy Centre for Inclusive Growth.
  7. Alessandro Prati & Thierry Tressel, 2006. "What is the Most Effective Monetary Policy for Aid-Receiving Countries?," Working Papers 12, United Nations, Department of Economics and Social Affairs.
  8. Nkunde Mwase, 2006. "An Empirical Investigation of the Exchange Rate Pass-Through to Inflation in Tanzania," IMF Working Papers 06/150, International Monetary Fund.
  9. Christopher Adam & Stephen O'Connell & Edward Buffie, 2008. "Aid volatility, monetary policy rules and the capital account in African economies," WEF Working Papers 0037, ESRC World Economy and Finance Research Programme, Birkbeck, University of London.
  10. Daniela Gabor, 2012. "Managing Capital Accounts in Emerging Markets: Lessons from the Global Financial Crisis," Journal of Development Studies, Taylor & Francis Journals, vol. 48(6), pages 714-731, June.
  11. Edward Buffie & Christopher Adam & Stephen O'Connell & Catherine Patillo, 2006. "Riding the Wave: Monetary Responses to Aid Surges in Low-Income Countries," CSAE Working Paper Series 2006-04, Centre for the Study of African Economies, University of Oxford.
  12. Mumtaz Hussain & Andrew Berg & Shekhar Aiyar, 2009. "The Macroeconomic Management of Increased Aid: Policy Lessons from Recent Experience," Review of Development Economics, Wiley Blackwell, vol. 13(s1), pages 491-509, 08.
  13. Kang Yong Tan & David Vines, 2007. "Woodford goes to Africa," WEF Working Papers 0029, ESRC World Economy and Finance Research Programme, Birkbeck, University of London.
  14. Pedro M. G. Martins, 2010. "Do Capital Inflows Hinder Competitiveness? The Real Exchange Rate in Ethiopia," Working Paper Series 1110, Department of Economics, University of Sussex.
  15. Thierry Tressel & Alessandro Prati, 2006. "Aid Volatility and Dutch Disease," IMF Working Papers 06/145, International Monetary Fund.
  16. Pedro M G Martins, . "Capital Inflows Hinder Competitiveness? The Real Exchange Rate in Ethiopia," Discussion Papers 10/07, University of Nottingham, CREDIT.

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