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Aid, Volatility and Growth Again: When Aid Volatility Matters and When It Does Not

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Author Info
Chauvet, Lisa
Guillaumont, Patrick
Abstract

In previous papers we have argued that aid is likely to mitigate the negative effects of external shocks on economic growth (i.e., aid is more effective in countries that are more vulnerable to external shocks). Recently an important debate has emerged about the possible negative effects of aid volatility itself. However, the cushioning effect of aid may involve some volatility in aid flows, which then is not necessarily negative for growth. In this paper we examine to what extent the time profile of aid disbursements may contribute to an increase or a decrease of aid effectiveness. We first show that aid, even if volatile, is not clearly as procyclical as often argued, and, even if procyclical, is not necessarily destabilizing. We measure aid volatility by several methods and assess procyclicality of aid with respect to exports, thus departing from previous literature, which usually assesses procyclicality of aid with respect to national income or fiscal receipts. The stabilizing/destabilizing nature of aid is measured by the difference in the volatility of exports and the volatility of the aid plus exports flows. Then, in order to take into account the diversity of shocks to which aid can respond, we consider the effect of aid on income volatility and again find that aid is making growth more stable, while its volatility reduces this effect. Finally, we find evidence through growth regressions that the higher effectiveness of aid in vulnerable countries is to a large extent due to its stabilizing effect.

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Paper provided by World Institute for Development Economic Research (UNU-WIDER) in its series Working Papers with number RP2008/78.

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Length: 16 pages
Date of creation: 2008
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Handle: RePEc:unu:wpaper:rp2008-78

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Keywords: aid; shocks; stability; growth;

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  2. Tavares, Jose, 2003. "Does foreign aid corrupt?," Economics Letters, Elsevier, vol. 79(1), pages 99-106, April. [Downloadable!] (restricted)
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  6. Fielding, David & Mavrotas, George, 2005. "The Volatility of Aid," Working Papers DP2005/06, World Institute for Development Economic Research (UNU-WIDER). [Downloadable!]
  7. Craig Burnside & David Dollar, 2000. "Aid, Policies, and Growth," American Economic Review, American Economic Association, vol. 90(4), pages 847-868, September. [Downloadable!] (restricted)
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  8. Pallage, Stephane & Robe, Michel A, 2001. "Foreign Aid and the Business Cycle," Review of International Economics, Blackwell Publishing, vol. 9(4), pages 641-72, November. [Downloadable!] (restricted)
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  9. Arellano, Manuel & Bover, Olympia, 1995. "Another look at the instrumental variable estimation of error-components models," Journal of Econometrics, Elsevier, vol. 68(1), pages 29-51, July. [Downloadable!] (restricted)
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  11. Hodrick, Robert J & Prescott, Edward C, 1997. "Postwar U.S. Business Cycles: An Empirical Investigation," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 29(1), pages 1-16, February.
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  12. Ale Bulir & A. Javier Hamann, 2003. "Aid Volatility: An Empirical Assessment," IMF Staff Papers, Palgrave Macmillan Journals, vol. 50(1), pages 4. [Downloadable!] (restricted)
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