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Aid volatility, monetary policy rules and the capital account in African economies

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Author Info
Christopher Adam (University of Oxford)
Stephen O'Connell (Swarthmore College)
Edward Buffie (Indiana University)

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Abstract

We examine the properties of simple quantity-based monetary policy rules of the kind widely used in low-income African economies. Using a DSGE model and focusing our attention on responses to positive aid shocks, we suggest that policy rules involving substantial reserve accumulation in the face of aid surges serve to ease macroeconomic adjustment to shocks, particularly when a portion of aid is used to support fiscal adjustment. These rules are robust to assumptions about the degree of integration of the domestic public debt market with world capital markets. Although an open capital account facilitates smoother adjustment to temporary aid surges when an aid inflow is fully spent, it exacerbates the adjustment problem when aid is accompanied by fiscal adjustment and hence reinforces the case for a managed float in such circumstances.

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Paper provided by ESRC World Economy and Finance Research Programme, Birkbeck, University of London in its series WEF Working Papers with number 0037.

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Date of creation: Jun 2008
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Handle: RePEc:wef:wpaper:0037

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Related research
Keywords: Monetary policy; Africa; Aid volatility; foreign capital flows; stochastic simulation models;

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  1. Pierpaolo Benigno & Michael Woodford, 2006. "Optimal Inflation Targeting under Alternative Fiscal Regimes," NBER Working Papers 12158, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  2. Calvo, Guillermo A. & Reinhart, Carmen M. & Vegh, Carlos A., 1995. "Targeting the real exchange rate: theory and evidence," Journal of Development Economics, Elsevier, vol. 47(1), pages 97-133, June. [Downloadable!] (restricted)
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  3. Adam, Christopher S. & Buffie, Edward & O'Connell, Stephen & Pattillo, Catherine, 2008. "Monetary Policy Rules for Managing Aid Surges in Africa," Working Papers RP2008/77, World Institute for Development Economic Research (UNU-WIDER). [Downloadable!]
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  4. Edward F. Buffie & Christopher Adam & Catherine A. Pattillo & Stephen A. O'Connell, 2004. "Exchange Rate Policy and the Management of Official and Private Capital Flows in Africa," IMF Working Papers 04/216, International Monetary Fund.
  5. Kang Yong Tan & David Vines, 2007. "Woodford goes to Africa," WEF Working Papers 0029, ESRC World Economy and Finance Research Programme, Birkbeck, University of London. [Downloadable!]
  6. Juillard, Michel, 1996. "Dynare : a program for the resolution and simulation of dynamic models with forward variables through the use of a relaxation algorithm," CEPREMAP Working Papers (Couverture Orange) 9602, CEPREMAP. [Downloadable!]
  7. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September. [Downloadable!] (restricted)
  8. Luis Felipe Cespedes & Roberto Chang & Andres Velasco, 2002. "IS-LM-BP in the Pampas," NBER Working Papers 9337, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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