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The Macroeconomics of Medium-Term Aid Scaling-Up Scenarios

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  • Rafael Portillo
  • Andrew Berg
  • Jan Gottschalk
  • Luis-Felipe Zanna

Abstract

We develop a model to analyze the macroeconomic effects of a scaling-up of aid and assess the implications of different policy responses. The model features key structural characteristics of low-income countries, including varying degrees of public investment efficiency and a learning-by-doing (LBD) externality that captures Dutch disease effects. On the policy front, it distinguishes between spending the aid, which is controlled by the fiscal authority, and absorbing the aid - financing a higher current account deficit - which is influenced by the central bank''s reserve accumulation policies. We calibrate the model to Uganda and run several experiments. We find that a policy mix that results in full spending and absorption of aid can generate temporary demand and real exchange rate appreciation pressures, but also have a positive effect on real GDP in the medium term, through higher public capital. Full spending with partial absorption, on the other hand, may stem appreciation pressures but can also induce adverse medium-term real GDP effects, through private sector crowding out. When aid is very inefficiently invested and there are strong LBD externalities, aid can be harmful, and partial absorption policies may be justified. But in this case, a welfare improving solution is to defer spending or - even better if possible - raise its efficiency.

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Bibliographic Info

Paper provided by International Monetary Fund in its series IMF Working Papers with number 10/160.

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Length: 45
Date of creation: 01 Jul 2010
Date of revision:
Handle: RePEc:imf:imfwpa:10/160

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Related research

Keywords: Africa; Fiscal policy; Monetary policy; Public investment; Aid flows; Economic assistance; Economic models; Exchange rate appreciation; Gross domestic product; Low-income developing countries; Reserves accumulation; exchange rate; real exchange rate; exchange rate regime; private investment; private capital; fixed exchange rate; real exchange rate appreciation; fixed exchange rate regime; foreign exchange; flexible exchange rate regime; flexible exchange rate; foreign currency; rate of return; real interest rates; investment spending; exchange sales; foreign exchange sales; net foreign assets; rates of return; nominal exchange rate; flexible exchange rates; exchange rates; tax rate; factor markets; internal rate of return; short interest; investment rate; fixed exchange rate regimes; exchange rate regimes; exchange reserves; institutional development; fixed capital; exchange rate target; factor mobility; nominal interest rates; currency appreciation; foreign exchange reserves; exchange rate adjustments; exchange rate policy;

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References

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  1. Agénor, Pierre-Richard & Bayraktar, Nihal & El Aynaoui, Karim, 2008. "Roads out of poverty? Assessing the links between aid, public investment, growth, and poverty reduction," Journal of Development Economics, Elsevier, vol. 86(2), pages 277-295, June.
  2. 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.
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Cited by:
  1. SENBETA, Sisay Regassa, 2013. "Informality and macroeconomic fluctuations: A small open economy New Keynesian DSGE model with dual labour markets," Working Papers 2013002, University of Antwerp, Faculty of Applied Economics.
  2. SENBATA, Sisay Regassa, 2011. "How applicable are the new Keynesian DSGE models to a typical low-income economy?," Working Papers 2011016, University of Antwerp, Faculty of Applied Economics.

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