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Monetary Policy Response to Capital Inflows in Form of Foreign Aid in Malawi

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Author Info

  • Manoel Bittencourt

    () (Department of Economics, University of Pretoria)

  • Chance Mwabutwa

    () (Department of Economics, University of Pretoria)

  • Nicola Viegi

    () (Department of Economics, University of Pretoria)

Abstract

This paper estimates the Bayesian dynamic stochastic general equilibrium (DSGE) model and uses the model to account for the short-run monetary policy response to increased aid inflows in Malawi. The estimates reveal that the monetary authorities reacted to increased foreign aid inflows the same way as was experienced in other African countries. The model also suggests that there was non-existence of the threats of the ‘Dutch Disease’ in contrast to what was found in Mozambique. The country can continue to receive aid by targeting the supply side of the economy with an aim of improving the competiveness of the export sector. Evidently, the conduct of monetary policy performs better under the assumption of full accessibility of financial assets. In addition, the impact of aid inflows on depreciation and inflation are much smaller when monetary authorities indulge in money targeting other than following the Taylor rule and incomplete sterilisation. On the small note, the study suggests that actual spending of aid should be aligned with the actual absorption of increased aid. Nevertheless, the outcome of the aid effects has been clouded out by the limitation of the exchange rate management in Malawi.

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Bibliographic Info

Paper provided by University of Pretoria, Department of Economics in its series Working Papers with number 201232.

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Length: 38 pages
Date of creation: Dec 2012
Date of revision:
Handle: RePEc:pre:wpaper:201232

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Related research

Keywords: Taylor Rule; DSGE Model; Rule-of-Thumb; Spending; Absorption; Foreign Exchange Rate; Bayesian Methods;

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References

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  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.
  2. Sonja Fagernäs & John Roberts, 2004. "The Fiscal Effects of Aid in Zambia," Working Papers 10, Economics and Statistics Analysis Unit (ESAU), Overseas Development Institute.
  3. Jordi Galí & J. David López Salido & Javier Vallés, 2003. "Rule-of-thumb consumers and the design of interest rate rules," Banco de España Working Papers 0320, Banco de España.
  4. Smets, Frank & Wouters, Rafael, 2007. "Shocks and Frictions in US Business Cycles: A Bayesian DSGE Approach," CEPR Discussion Papers 6112, C.E.P.R. Discussion Papers.
  5. Catherine A. Pattillo & Stephen A. O'Connell & Christopher Adam & Edward F. Buffie, 2004. "Exchange Rate Policy and the Management of Official and Private Capital Flows in Africa," IMF Working Papers 04/216, International Monetary Fund.
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  7. Fielding, David & Gibson, Fred, 2012. "Aid and Dutch Disease in Sub-Saharan Africa," Working Papers UNU-WIDER Research Paper , World Institute for Development Economic Research (UNU-WIDER).
  8. Chance Mwabutwa & Manoel Bittencourt & Nicola Viegi, 2012. "Financial Reforms and Consumption Behaviour in Malawi," Working Papers 306, Economic Research Southern Africa.
  9. Luis-Felipe Zanna & Andrew Berg & Tokhir Mirzoev & Rafael Portillo, 2010. "The Short-Run Macroeconomics of Aid Inflows: Understanding the Interaction of Fiscal and Reserve Policy," IMF Working Papers 10/65, International Monetary Fund.
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  12. Isabell Adenauer & Laurence Vagassky, 1998. "Aid and the real exchange rate: Dutch disease effects in African countries," Intereconomics: Review of European Economic Policy, Springer, vol. 33(4), pages 177-185, July.
  13. repec:fth:harver:1435 is not listed on IDEAS
  14. DeJong, David N. & Ingram, Beth F. & Whiteman, Charles H., 2000. "A Bayesian approach to dynamic macroeconomics," Journal of Econometrics, Elsevier, vol. 98(2), pages 203-223, October.
  15. Shanaka J. Peiris & Magnus Saxegaard, 2007. "An Estimated DSGE Model for Monetary Policy analysis in Low-Income Countries," IMF Working Papers 07/282, International Monetary Fund.
  16. Frank Smets & Raf Wouters, 2003. "An Estimated Dynamic Stochastic General Equilibrium Model of the Euro Area," Journal of the European Economic Association, MIT Press, vol. 1(5), pages 1123-1175, 09.
  17. Elbadawi, Ibrahim A, 1999. "External Aid: Help or Hindrance to Export Orientation in Africa?," Journal of African Economies, Centre for the Study of African Economies (CSAE), vol. 8(4), pages 578-616, December.
  18. B Ouattara & E Strobl, 2003. "Do Aid Inflows Cause Dutch Disease? A Case Study of the CFA Franc Countries," The School of Economics Discussion Paper Series 0330, Economics, The University of Manchester.
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