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Aid, Growth, and Real Exchange Rate Dynamics

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  • Devarajan, Shantayanan
  • Go, Delfin S.
  • Robinson, Sherman
  • Thierfelder, Karen

Abstract

We argue that if aid is about the future and recipients are able to plan consumption and investment decisions optimally over time, then the potential problem of an aid-induced appreciation of the real exchange rate (Dutch disease) does not occur. Furthermore, greater economic flexibility and an increasing degree of integration to the global economy will intensify the changes in the real exchange rate as well as investment, consumption and exports. This key result is derived without requiring additional assumptions such as exogenous or endogenous productivity growth. The economic framework is a standard neoclassical growth model, based on the familiar Salter-Swan characterization of an open economy, with full dynamic savings and investment decisions. It does require that the model is fully dynamic in both savings and investment decisions. An important assumption is that aid should be predictable for intertemporal smoothing to take place. If aid volatility forces recipients to be constrained and myopic, Dutch disease problems become an issue. In short, any unfavorable macroeconomic dynamics of scaled-up aid are the result of donor behavior rather than the functioning of recipient economies.

Suggested Citation

  • Devarajan, Shantayanan & Go, Delfin S. & Robinson, Sherman & Thierfelder, Karen, 2011. "Aid, Growth, and Real Exchange Rate Dynamics," Conference papers 332129, Purdue University, Center for Global Trade Analysis, Global Trade Analysis Project.
    • Handle: RePEc:ags:pugtwp:332129
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    Cited by:

    1. Matthias Helble & Catherine Mann & John Wilson, 2012. "Aid-for-trade facilitation," Review of World Economics (Weltwirtschaftliches Archiv), Springer;Institut für Weltwirtschaft (Kiel Institute for the World Economy), vol. 148(2), pages 357-376, June.
    2. Pedro M. G. Martins, 2010. "Do Capital Inflows Hinder Competitiveness? The Real Exchange Rate in Ethiopia," Working Paper Series 1110, Department of Economics, University of Sussex Business School.
    3. Valerie Cerra & Serpil Tekin & Stephen Turnovsky, 2009. "Foreign Transfers and Real Exchange Rate Adjustments in a Financially Constrained Dependent Economy," Open Economies Review, Springer, vol. 20(2), pages 147-181, April.

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