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The Macroeconomic Management of Increased Aid: Policy Lessons from Recent Experience

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Author Info
Aiyar, Shekhar
Berg, Andrew
Hussain, Mumtaz

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Abstract

This paper investigates the macroeconomic challenges created by a surge in aid inflows. It develops an analytical framework for examining possible policy responses to increased aid, in terms of absorption and spending of aid?where the central bank controls absorption through monetary policy and the sale of foreign exchange and the fiscal authority controls spending. Different combinations of absorption and spending lead to different macroeconomic consequences. Evidence from five countries that recently experienced an aid surge (Ethiopia, Ghana, Tanzania, Mozambique and Uganda) shows no support for aid-related real exchange rate appreciation in these countries, but indicates that the fear of Dutch disease played an important part in the policy reaction to aid surges. Fiscal and monetary authorities should coordinate their responses to an aid surge, because an uncoordinated response?typically when fiscal authority wants to spend aid while the central bank wants to avoid exchange rate appreciation?can have serious negative macroeconomic consequences.

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File URL: http://www.wider.unu.edu/stc/repec/pdfs/rp2008/rp2008-79.pdf
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Publisher Info
Paper provided by World Institute for Development Economic Research (UNU-WIDER) in its series Working Papers with number RP2008/79.

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Length: 22 pages
Date of creation: 2008
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Handle: RePEc:unu:wpaper:rp2008-79

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Related research
Keywords: aid; exchange rate; aid absorption; policy;

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This paper has been announced in the following NEP Reports: References listed on IDEAS
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  1. McGillivray, Mark & Morrissey, Oliver, 2001. "Fiscal Effects of Aid," Working Papers UNU-WIDER Research Paper , World Institute for Development Economic Research (UNU-WIDER). [Downloadable!]
  2. Cristina Arellano & Aleš Bulir & Timothy D. Lane & Leslie Lipschitz, 2005. "The Dynamic Implications of Foreign Aid and Its Variability," IMF Working Papers 05/119, International Monetary Fund. [Downloadable!]
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  3. Raghuram G. Rajan & Arvind Subramanian, 2005. "What Undermines Aid's Impact on Growth?," NBER Working Papers 11657, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  4. Shekhar Aiyar & Shaun K. Roache & Mumtaz Hussain & Tokhir N. Mirzoev & Amber Mahone & Andrew Berg, 2007. "The Macroeconomics of Scaling Up Aid: Lessons from Recent Experience," IMF Occasional Papers 253, International Monetary Fund.
  5. Philip R. Lane & Gian Maria Milesi-Ferretti, 2004. "The Transfer Problem Revisited: Net Foreign Assets and Real Exchange Rates," The Review of Economics and Statistics, MIT Press, vol. 86(4), pages 841-857, 02. [Downloadable!] (restricted)
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  6. Edward F. Buffie & Christopher Adam & Catherine A. Pattillo & Stephen A. O'Connell, 2007. "Monetary Policy Rules for Managing Aid Surges in Africa," IMF Working Papers 07/180, International Monetary Fund. [Downloadable!]
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