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Aid Volatility and Dutch Disease

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  • Thierry Tressel
  • Alessandro Prati

Abstract

This paper studies how macroeconomic policies can help offset two unintended and undesirable features of foreign aid: its volatility and Dutch disease. We present evidence that aid volatility augments trade balance volatility and that foreign aid, with the important exception of years of adverse shocks, depresses exports. We also find that these effects can be mitigated through changes in net domestic assets of the central bank-a variable that reflects both monetary and fiscal policy. To characterize the optimal policy, we develop a general equilibrium model in which the capital account is closed and aid influences productivity growth through positive (public expenditure) and negative (Dutch disease) externalities. In this setting, macroeconomic policies permanently affect real variables and can improve welfare if donors do not distribute foreign aid optimally over time.

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Bibliographic Info

Paper provided by International Monetary Fund in its series IMF Working Papers with number 06/145.

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Length: 65
Date of creation: 01 Jun 2006
Date of revision:
Handle: RePEc:imf:imfwpa:06/145

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Related research

Keywords: Real effective exchange rates; Monetary policy; central bank; foreign aid; current account; money demand; money supply; monetary fund; money balances; domestic debt; aggregate demand; domestic currency; current account balance; demand for money; money market; monetary authority; current account balances; monetary sector; domestic currencies; monetary authorities; monetary impact; monetary determinants; external financing; open market operations; current accounts; discount rate; reserve accumulation; monetary policies; expansionary monetary policy; public debt; monetary policy implementation; central banks; inflation; domestic debt issuance; domestic agents; external shocks; monetary stance; monetary policy decisions; domestic public debt; current account deficits; current account surplus; government debt; domestic monetary policy; private sector debt; monetary expansion; tight monetary policy; stock of debt;

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References

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