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Monetary Policy Rules for Managing Aid Surges in Africa

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

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Abstract

Since the turn of the century, aid flows to Africa have increased on average and become more volatile. As a result, policymakers, particularly in post-stabilization countries where inflation has only recently been brought under control, have been increasingly preoccupied with how best to deploy the available instruments of monetary policy without yielding on hard-won inflation gains. We use a stochastic simulation model, in which private sector currency substitution effects play a central role, to examine the properties of alternative monetary and fiscal policy strategies in the face of volatile aid flows. We show that simple monetary rules, specifically an (unsterilized) exchange rate crawl and a 'reserve buffer plus float'-under which the authorities set a time-varying reserve target corresponding to the unspent portion of aid financing and allow the exchange rate to float freely once this reserve target is satisfied-have attractive properties relative to a range of alternative strategies including those involving heavy reliance on bond sterilization or a commitment to a 'pure' exchange rate float.

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Paper provided by International Monetary Fund in its series IMF Working Papers with number 07/180.

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Length: 40 pages
Date of creation: 26 Jul 2007
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Handle: RePEc:imf:imfwpa:07/180

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Keywords: Working Paper ; Development assistance ; Monetary policy ; Africa ; Economic models ;

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This paper has been announced in the following NEP Reports: References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Sanjeev Gupta & Catherine Pattillo & Smita Wagh, 2006. "Are Donor Countries Giving More or Less Aid?," Review of Development Economics, Blackwell Publishing, vol. 10(3), pages 535-552, 08. [Downloadable!] (restricted)
  2. Smita Wagh & Sanjeev Gupta & Catherine A. Pattillo, 2006. "Are Donor Countries Giving More or Less Aid?," IMF Working Papers 06/1, International Monetary Fund. [Downloadable!]
  3. Calvo, Guillermo A. & Reinhart, Carmen M. & Vegh, Carlos A., 1995. "Targeting the real exchange rate: theory and evidence," Journal of Development Economics, Elsevier, vol. 47(1), pages 97-133, June. [Downloadable!] (restricted)
    Other versions:
  4. Edward F. Buffie & Christopher Adam & Catherine A. Pattillo & Stephen A. O'Connell, 2007. "Monetary Policy Rules for Managing Aid Surges in Africa," IMF Working Papers 07/180, International Monetary Fund. [Downloadable!]
    Other versions:
  5. Edward F. Buffie & Christopher Adam & Catherine A. Pattillo & Stephen A. O'Connell, 2004. "Exchange Rate Policy and the Management of Official and Private Capital Flows in Africa," IMF Working Papers 04/216, International Monetary Fund.
  6. Ale� Bulir & A. Javier Hamann, 2006. "Volatility of Development Aid: From the Frying Pan Into the Fire?," IMF Working Papers 06/65, International Monetary Fund. [Downloadable!]
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  7. Juillard, Michel, 1996. "Dynare : a program for the resolution and simulation of dynamic models with forward variables through the use of a relaxation algorithm," CEPREMAP Working Papers (Couverture Orange) 9602, CEPREMAP. [Downloadable!]
  8. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September. [Downloadable!] (restricted)
  9. 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, vol. 52(8), pages 1378-1395, November. [Downloadable!] (restricted)
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(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Christopher Adam & Stephen O’Connell & Edward Buffie, 2007. "Monetary Policy Rules For Manging Aid Surges In Africa," WEF Working Papers 0016, ESRC World Economy and Finance Research Programme, Birkbeck, University of London. [Downloadable!]
    Other versions:
  2. KAMGNA, Severin Yves & Ndambendia, Houdou, 2008. "Excès de liquidité systémique et effectivité de la politique monétaire : cas des pays de la CEMAC
    [Excess liquidity and monetary policy effectiveness: The case of CEMAC countries]    ," MPRA Paper 9599, University Library of Munich, Germany. [Downloadable!]
  3. 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. [Downloadable!]
  4. Paolo Dudine & Markus Berndt & Abu Shonchoy & Jan Kees Martijn, 2008. "The Spending and Absorption of Aid in PRGF Supported Programs," IMF Working Papers 08/237, International Monetary Fund. [Downloadable!]
  5. Aiyar, Shekhar & Berg, Andrew & Hussain, Mumtaz, 2008. "The Macroeconomic Management of Increased Aid: Policy Lessons from Recent Experience," Working Papers RP2008/79, World Institute for Development Economic Research (UNU-WIDER). [Downloadable!]
    Other versions:
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