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Policy Responses to Aid Surges in Countries with Limited International Capital Mobility: The Role of the Exchange Rate Regime

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Author Info

  • Andrew Berg
  • Rafael A Portillo
  • Luis-Felipe Zanna

Abstract

We study the role of the exchange rate regime, reserve accumulation, and sterilization policies in the macroeconomics of aid surges. Absent sterilization, a peg allows for almost full aid absorption — an increase in the current account deficit net of aid—delivering the same effects as those of a flexible regime but with a necessary increase in inflation. Regardless of the regime, policies that limit absorption—and result in large accumulation of reserves—are welfare reducing: they help reduce the real appreciation (and inflation under the peg), but at the expense of reducing private consumption and investment, and therefore medium-term growth.

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Bibliographic Info

Paper provided by International Monetary Fund in its series IMF Working Papers with number 14/18.

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Length: 41
Date of creation: 30 Jan 2014
Date of revision:
Handle: RePEc:imf:imfwpa:14/18

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Related research

Keywords: Exchange rate regimes; Aid flows; Africa; Foreign exchange; Reserves accumulation; Central banks; Monetary policy; Fiscal policy; Economic models; Reserve Accumulation Policies; Sterilization Policies; Transfer Problem.; fixed exchange rate; fixed exchange rate regime; flexible exchange rate; flexible exchange rate regime; real exchange rate; exchange rate appreciation; exchange rates; real exchange rate appreciation; fixed exchange rate regimes; nominal exchange rate; flexible exchange rates; flexible exchange rate regimes; exchange sales; exchange rate commitment; foreign exchange sales; exchange rate policies; currency substitution; exchange rate peg; exchange reserves; fixed exchange rates; foreign exchange reserves; exchange rate policy; exchange rate target;

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References

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  1. Matsuyama, Kiminori, 1992. "Agricultural productivity, comparative advantage, and economic growth," Journal of Economic Theory, Elsevier, Elsevier, vol. 58(2), pages 317-334, December.
  2. H. Issa & B. Ouattara, 2008. "Foreign Aid Flows And Real Exchange Rate: Evidence From Syria," Journal of Economic Development, Chung-Ang Unviersity, Department of Economics, Chung-Ang Unviersity, Department of Economics, vol. 33(1), pages 133-146, June.
  3. 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.
  4. Pierre‐Richard Agénor & Devrim Yilmaz, 2013. "Aid Allocation, Growth And Welfare With Productive Public Goods," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 18(2), pages 103-127, 03.
  5. Rotemberg, Julio J, 1982. "Sticky Prices in the United States," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 90(6), pages 1187-1211, December.
  6. Santanu Chatterjee & Stephen Turnovsky, 2005. "Foreign Aid and Economic Growth: The Role of Flexible Labor Supply," Working Papers, University of Washington, Department of Economics UWEC-2004-07-P, University of Washington, Department of Economics, revised Nov 2005.
  7. Schmitt-Grohé, Stephanie & Uribe, Martín, 2004. "Optimal Simple and Implementable Monetary and Fiscal Rules," CEPR Discussion Papers, C.E.P.R. Discussion Papers 4334, C.E.P.R. Discussion Papers.
  8. 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.
  9. Agenor, Pierre-Richard & Bayraktar, Nihal & El Aynaoui, Karim, 2005. "Roads out of poverty? assessing the links between aid, public investment, growth, and poverty reduction," Policy Research Working Paper Series 3490, The World Bank.
  10. Timothy D. Lane & Leslie Lipschitz & Cristina Arellano & Ales Bulir, 2005. "The Dynamic Implications of Foreign Aid and its Variability," IMF Working Papers 05/119, International Monetary Fund.
  11. Andrew Berg & Mumtaz Hussain & Shaun K. Roache & Amber Mahone & Tokhir N. Mirzoev & Shekhar Aiyar, 2007. "The Macroeconomics of Scaling Up Aid," IMF Occasional Papers 253, International Monetary Fund.
  12. Shekhar Aiyar & Ummul Hasanath Ruthbah, 2008. "Where Did All the Aid Go? An Empirical Analysis of Absorption and Spending," IMF Working Papers 08/34, International Monetary Fund.
  13. Martin Schindler, 2009. "Measuring Financial Integration: A New Data Set," IMF Staff Papers, Palgrave Macmillan, vol. 56(1), pages 222-238, April.
  14. Carl-Johan Dalgaard & Henrik Hansen, 2005. "The Return to Foreign Aid," Discussion Papers 05-04, University of Copenhagen. Department of Economics.
  15. repec:fth:stanho:e-92-3 is not listed on IDEAS
  16. Bazoumana Ouattara & Eric Strobl, 2008. "Foreign Aid Inflows And The Real Exchange Rate In The Cfa Franc Zone," Economie Internationale, CEPII research center, CEPII research center, issue 116, pages 37-52.
  17. Valerie Cerra & Serpil Tekin & Stephen Turnovsky, 2009. "Foreign Transfers and Real Exchange Rate Adjustments in a Financially Constrained Dependent Economy," Open Economies Review, Springer, Springer, vol. 20(2), pages 147-181, April.
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