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Riding the Wave: Monetary Responses to Aid Surges in Low-Income Countries

  • Edward Buffie
  • Christopher Adam
  • Stephen O'Connell
  • Catherine Patillo

We focus on the management of highly persistent shocks to aid flows, including HIPC or MDG-related increases in net flows, in the presence of currency substitution by the domestic private sector. Such shocks have beneficent long-run effects, but when currency substitution is high they can produce dramatic macroeconomic management problems in the short run. What is the appropriate mix of money and exchange rate targeting in such cases, and the role of temporary sterilization? We analyze these and related issues in an intertemporal optimizing model that allows a portion of aid to be devoted to reducing the government’s seigniorage requirement. Our results argue that a managed float, with little or no sterilization of increases in the monetary base, is the most attractive approach.

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Paper provided by Centre for the Study of African Economies, University of Oxford in its series CSAE Working Paper Series with number 2006-04.

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Date of creation: 2006
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Handle: RePEc:csa:wpaper:2006-04
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