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Aid inflows and the real effective exchange rate in Tanzania

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  • Li, Ying
  • Rowe, Francis
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    Abstract

    Tanzania is well placed to receive a significant increase in aid inflows in coming years. Despite the potential for the additional aid inflows to raise income levels in the country, increasing them may bring about structural changes in the economy that may be unwelcome. One such change is an appreciation of the real exchange rate that leads to a contraction of traditional export sectors and a loss of export competitiveness. This paper employs a reduced-form equilibrium real exchange rate approach to explain movements in Tanzania's real effective exchange in recent decades. Particular attention is paid to the relationship between aid inflows and the real effective exchange rate. The authors find that the long-run behavior of the real effective exchange rate is influenced by terms of trade movements, the government's trade liberalization efforts, and aid inflows. Positive terms-of-trade movements are associated with an appreciation, periods of improving trade liberalization are associated with a depreciation, and increases in aid inflows are associated with a depreciation in the real effective exchange rate. Although the last result is non-standard, it is not empirically unique and does have theoretical underpinnings. A detailed analysis of this relationship over the last decade shows that the Bank of Tanzania's response to aid inflows is likely the main reason for the finding.

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    Bibliographic Info

    Paper provided by The World Bank in its series Policy Research Working Paper Series with number 4456.

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    Date of creation: 01 Dec 2007
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    Handle: RePEc:wbk:wbrwps:4456

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    Keywords: Currencies and Exchange Rates; Debt Markets; Economic Theory&Research; Emerging Markets; Economic Stabilization;

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    1. Christopher Adam & David Bevan, 2000. "Exchange Rate Regimes and Revenue Performance in Sub-Saharan Africa," Economics Series Working Papers 9, University of Oxford, Department of Economics.
    2. Edwards, Sebastian, 1989. "Exchange Rate Misalignment in Developing Countries," World Bank Research Observer, World Bank Group, vol. 4(1), pages 3-21, January.
    3. Menzie Chinn, 2006. "A Primer on Real Effective Exchange Rates: Determinants, Overvaluation, Trade Flows and Competitive Devaluation," Open Economies Review, Springer, vol. 17(1), pages 115-143, January.
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    7. Christopher S. Adam & David L. Bevan, 2006. "Aid and the Supply Side: Public Investment, Export Performance, and Dutch Disease in Low-Income Countries," World Bank Economic Review, World Bank Group, vol. 20(2), pages 261-290.
    8. Volker Treichel, 2005. "Tanzania's Growth Process and Success in Reducing Poverty," IMF Working Papers 05/35, International Monetary Fund.
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    14. Bazoumana Ouattara & Eric Strobl, 2008. "Foreign Aid Inflows And The Real Exchange Rate In The Cfa Franc Zone," Economie Internationale, CEPII research center, issue 116, pages 37-52.
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    16. White, Howard & Wignaraja, Ganeshan, 1992. "Exchange rates, trade liberalization and aid: The Sri Lankan experience," World Development, Elsevier, vol. 20(10), pages 1471-1480, October.
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    18. Elbadawi, Ibrahim A. & Soto, Raimundo, 1994. "Capital flows and long-term equilibrium real exchange rates in Chile," Policy Research Working Paper Series 1306, The World Bank.
    19. International Monetary Fund, 2003. "The Equilibrium Real Exchange Rate in a Commodity Exporting Country," IMF Working Papers 03/93, International Monetary Fund.
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    23. repec:fth:oxesaf:97-16 is not listed on IDEAS
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    Cited by:
    1. Luc Savard, 2010. "Scaling up Infrastructure spending in the Philippines: A CGE top-down/bottom up microsimulation approach," Cahiers de recherche 10-06, Departement d'Economique de la Faculte d'administration à l'Universite de Sherbrooke.

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