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Monetary Policy Rules for Managing Aid Surges in Africa

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Author Info

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

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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Bibliographic Info

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

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Length: 40
Date of creation: 01 Jul 2007
Date of revision:
Handle: RePEc:imf:imfwpa:07/180

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Keywords: Economic models; exchange rate; inflation; foreign exchange; real exchange rate; monetary policy; nominal exchange rate; foreign currency; steady-state inflation; currency substitution; foreign exchange sales; exchange sales; nominal interest rate; exchange rate target; monetary base; exchange rate volatility; exchange rate targeting; inflation rate; inflation tax; real interest rate; exchange rate appreciation; real exchange rates; exchange rate movements; real exchange rate volatility; real exchange rate appreciation; inflation stabilization; low inflation; exchange rate policy; foreign exchange market; price level; real interest rates; aggregate demand; exchange reserves; inflation target; exchange rates; high inflation; money supply; exchange rate float; foreign exchange reserves; exchange rate floats; nominal exchange rate depreciation; real exchange rate movements; monetary economics; reduction in inflation; exchange rate targets; real exchange rate movement; exchange rate movement; inflation targeting; money stock; exchange markets; price inflation; exchange rate adjustment; exchange operations; foreign exchange operations; terms of trade; foreign exchange markets; exchange rate arrangements; exchange rate depreciation; money growth; nominal interest rates;

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References

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  1. Buffie, Edward F. & O'Connell, Stephen A. & Adam, Christopher, 2010. "Fiscal inertia, donor credibility, and the monetary management of aid surges," Journal of Development Economics, Elsevier, vol. 93(2), pages 287-298, November.
  2. 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.
  3. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
  4. Edward Buffie & Christopher Adam & Stephen O'Connell & Catherine Pattillo, 2004. "Exchange Rate Policy and the Management of Official and Private Capital Flows in Africa," IMF Staff Papers, Palgrave Macmillan, vol. 51(s1), pages 126-160, June.
  5. 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.
  6. 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.
  7. 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.
  8. Sanjeev Gupta & Catherine A. Pattillo & Smita Wagh, 2006. "Are Donor Countries Giving More or Less Aid?," IMF Working Papers 06/1, International Monetary Fund.
  9. A. Javier Hamann & Ales Bulir, 2006. "Volatility of Development Aid," IMF Working Papers 06/65, International Monetary Fund.
  10. 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.
  11. Sanjeev Gupta & Catherine Pattillo & Smita Wagh, 2006. "Are Donor Countries Giving More or Less Aid?," Review of Development Economics, Wiley Blackwell, vol. 10(3), pages 535-552, 08.
  12. Edward F. Buffie, 2003. "Tight Money, Real Interest Rates, and Inflation in Sub-Saharan Africa," IMF Staff Papers, Palgrave Macmillan, vol. 50(1), pages 6.
  13. 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.
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Citations

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Cited by:
  1. Edward F. Buffie & Stephen A. O'Connell & Catherine A. Pattillo & Christopher Adam, 2007. "Monetary Policy Rules for Managing Aid Surges in Africa," IMF Working Papers 07/180, International Monetary Fund.
  2. Senbeta, Sisay, 2011. "How applicable are the new keynesian DSGE models to a typical low-income economy?," MPRA Paper 30931, University Library of Munich, Germany.
  3. 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.
  4. SENBETA, Sisay Regassa, 2012. "How important are external shocks in explaining growth in Sub-Saharan Africa? Evidence from a Bayesian VAR," Working Papers 2012010, University of Antwerp, Faculty of Applied Economics.
  5. Aiyar, Shekhar & Berg, Andrew & Hussain, Mumtaz, 2008. "The Macroeconomic Management of Increased Aid: Policy Lessons from Recent Experience," Working Paper Series RP2008/79, World Institute for Development Economic Research (UNU-WIDER).
  6. Christopher Adam, 2006. "Riding the Wave: Monetary Responses to Aid Surges in Low-Income Countries," Economics Series Working Papers WPS/2006-04, University of Oxford, Department of Economics.
  7. Senbeta, Sisay, 2011. "A small open economy New Keynesian model for a foreign exchange constrained economy," MPRA Paper 29996, University Library of Munich, Germany.
  8. SENBETA, Sisay Regassa, 2011. "A small open economy new Keynesian DSGE model for a foreign exchange constrained economy," Working Papers 2011004, University of Antwerp, Faculty of Applied Economics.
  9. Jan Kees Martijn & Markus Berndt & Abu Shonchoy & Paolo Dudine, 2008. "The Spending and Absorption of Aid in PRGF Supported Programs," IMF Working Papers 08/237, International Monetary Fund.
  10. SENBETA, Sisay Regassa, 2013. "Foreign exchange constraints and macroeconomic dynamics in a small open economy," Working Papers 2013023, University of Antwerp, Faculty of Applied Economics.
  11. 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.
  12. Ruslan Aliyev, 2012. "Monetary Policy in Resource-Rich Developing Economies," CERGE-EI Working Papers wp466, The Center for Economic Research and Graduate Education - Economic Institute, Prague.
  13. 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.

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