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

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  • Catherine A. Pattillo
  • Stephen A. O'Connell
  • Christopher Adam
  • Edward F. Buffie

Abstract

We focus on the management of highly persistent shocks to aid flows, including PRSP-related increases in net inflows, in three “post-stabilization.” African economies with de jure flexible exchange rates. 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 what is the role of temporary sterilization? We analyze these 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. 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 in the short run.

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Bibliographic Info

Paper provided by International Monetary Fund in its series IMF Working Papers with number 04/216.

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Length: 53
Date of creation: 01 Nov 2004
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Handle: RePEc:imf:imfwpa:04/216

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Keywords: Currency substitution; Capital flows; exchange rate; inflation; real exchange rate; foreign exchange; price level; foreign currency; real interest rate; nominal exchange rate; inflation rate; monetary policy; real money; flexible exchange rate; exchange rate regime; foreign exchange market; money growth; exchange rate system; lower inflation; flexible exchange rate system; real interest rates; exchange rate regimes; exchange sales; foreign exchange sales; exchange rates; money supply; inflationary pressures; exchange rate policy; floating exchange rate; low inflation; fixed exchange rate; real output; flexible exchange rates; relative price; currency depreciation; exchange rate systems; exchange reserves; exchange rate targeting; steady-state inflation; foreign exchange reserves; current account balance; macroeconomic stability; exchange rate flexibility; real exchange rates; real money supply; floating exchange rate regime; dollar value; high inflation; monetary economics; inflation target; inflation targeting; exchange rate targets; inflation tax; nominal interest rate; rational expectations; price elasticity; optimal exchange rate regime; exchange rate adjustment; fixed exchange rate systems; exchange rate arrangements; monetary base; annual inflation; exchange rate appreciation; flexible exchange rate regimes; terms of trade; increase in inflation; high interest rates;

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References

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  1. Asea, Patrick K & Reinhart, Carmen M, 1996. "Le Prix de l'Argent: How (Not) to Deal with Capital Inflows," Journal of African Economies, Centre for the Study of African Economies (CSAE), Centre for the Study of African Economies (CSAE), vol. 5(3), pages 231-71, October.
  2. Alfonso Novales & Emilio Dominguez & Javier J. Perez & Jesus Ruiz, 1998. "Solving Non-linear Rational Expectations Models By Eigenvalue-Eigenvector Decompositions," QM&RBC Codes, Quantitative Macroeconomics & Real Business Cycles 124, Quantitative Macroeconomics & Real Business Cycles.
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  7. C. L. Ramirez-Rojas, 1985. "Currency Substitution in Argentina, Mexico, and Uruguay (Substitution de monnaie en Argentine, au Mexique et en Uruguay) (Sustitución de moneda en Argentina, México y Uruguay)," IMF Staff Papers, Palgrave Macmillan, vol. 32(4), pages 629-667, December.
  8. Guillermo A. Calvo & Leonardo Leiderman & Carmen M. Reinhart, 1994. "The Capital Inflows Problem: Concepts And Issues," Contemporary Economic Policy, Western Economic Association International, Western Economic Association International, vol. 12(3), pages 54-66, 07.
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  15. Benedict J. Clements & Sanjeev Gupta & Emanuele Baldacci & Carlos Mulas-Granados, 2002. "Expenditure Composition, Fiscal Adjustment, and Growth in Low-Income Countries," IMF Working Papers 02/77, International Monetary Fund.
  16. Krishna Srinivasan & Erich Spitäller & M. Braulke & Christian B. Mulder & Hisanobu Shishido & Kenneth M. Miranda & John Dodsworth & Keon Lee, 1996. "Vietnam," IMF Occasional Papers 135, International Monetary Fund.
  17. Adam, Christopher, 1999. "Financial Liberalisation and Currency Demand in Zambia," Journal of African Economies, Centre for the Study of African Economies (CSAE), Centre for the Study of African Economies (CSAE), vol. 8(3), pages 268-306, October.
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Citations

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Cited by:
  1. Pedro M G Martins, . "Aid Absorption and Spending in Africa: A Panel Cointegration Approach," Discussion Papers 10/06, University of Nottingham, CREDIT.
  2. Andrew Berg & Rafael A Portillo & Luis-Felipe Zanna, 2014. "Policy Responses to Aid Surges in Countries with Limited International Capital Mobility: The Role of the Exchange Rate Regime," IMF Working Papers 14/18, International Monetary Fund.
  3. Daniela Gabor, 2012. "Managing Capital Accounts in Emerging Markets: Lessons from the Global Financial Crisis," Journal of Development Studies, Taylor & Francis Journals, Taylor & Francis Journals, vol. 48(6), pages 714-731, June.
  4. Buffie, Edward & Adam, Christopher & O'Connell, Stephen & Pattillo, Catherine, 2008. "Riding the wave: Monetary responses to aid surges in low-income countries," European Economic Review, Elsevier, Elsevier, vol. 52(8), pages 1378-1395, November.
  5. John Weeks, 2008. "The Reduction of Fiscal Space in Zambia?Dutch Disease and Tight-Money Conditionalities," Country Study, International Policy Centre for Inclusive Growth 14, International Policy Centre for Inclusive Growth.
  6. Pedro M G Martins, . "Capital Inflows Hinder Competitiveness? The Real Exchange Rate in Ethiopia," Discussion Papers 10/07, University of Nottingham, CREDIT.
  7. Christopher Adam & Stephen O’Connell & Edward Buffie, 2007. "Monetary Policy Rules For Manging Aid Surges In Africa," WEF Working Papers, ESRC World Economy and Finance Research Programme, Birkbeck, University of London 0016, ESRC World Economy and Finance Research Programme, Birkbeck, University of London.
  8. Aiyar, Shekhar & Berg, Andrew & Hussain, Mumtaz, 2008. "The Macroeconomic Management of Increased Aid: Policy Lessons from Recent Experience," Working Paper Series, World Institute for Development Economic Research (UNU-WIDER) RP2008/79, World Institute for Development Economic Research (UNU-WIDER).
  9. Thierry Tressel & Alessandro Prati, 2006. "Aid Volatility and Dutch Disease," IMF Working Papers 06/145, International Monetary Fund.
  10. 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.
  11. 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.
  12. Kang Yong Tan & David Vines, 2007. "Woodford goes to Africa," WEF Working Papers, ESRC World Economy and Finance Research Programme, Birkbeck, University of London 0029, ESRC World Economy and Finance Research Programme, Birkbeck, University of London.
  13. 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.
  14. 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.
  15. Christopher Adam & Stephen O'Connell & Edward Buffie, 2008. "Aid volatility, monetary policy rules and the capital account in African economies," WEF Working Papers, ESRC World Economy and Finance Research Programme, Birkbeck, University of London 0037, ESRC World Economy and Finance Research Programme, Birkbeck, University of London.
  16. Alessandro Prati & Thierry Tressel, 2006. "What is the Most Effective Monetary Policy for Aid-Receiving Countries?," Working Papers, United Nations, Department of Economics and Social Affairs 12, United Nations, Department of Economics and Social Affairs.
  17. Nkunde Mwase, 2006. "An Empirical Investigation of the Exchange Rate Pass-Through to Inflation in Tanzania," IMF Working Papers 06/150, International Monetary Fund.

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