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Aid Volatility and Dutch Disease; Is there a Role for Macroeconomic Policies?

  • Thierry Tressel
  • Alessandro Prati

This paper studies how macroeconomic policies can help offset two unintended and undesirable features of foreign aid: its volatility and Dutch disease. We present evidence that aid volatility augments trade balance volatility and that foreign aid, with the important exception of years of adverse shocks, depresses exports. We also find that these effects can be mitigated through changes in net domestic assets of the central bank-a variable that reflects both monetary and fiscal policy. To characterize the optimal policy, we develop a general equilibrium model in which the capital account is closed and aid influences productivity growth through positive (public expenditure) and negative (Dutch disease) externalities. In this setting, macroeconomic policies permanently affect real variables and can improve welfare if donors do not distribute foreign aid optimally over time.

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Paper provided by International Monetary Fund in its series IMF Working Papers with number 06/145.

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Length: 65
Date of creation: 01 Jun 2006
Date of revision:
Handle: RePEc:imf:imfwpa:06/145
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  1. Arellano, Cristina & Bulír, Ales & Lane, Timothy & Lipschitz, Leslie, 2009. "The dynamic implications of foreign aid and its variability," Journal of Development Economics, Elsevier, vol. 88(1), pages 87-102, January.
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  23. repec:rus:hseeco:181565 is not listed on IDEAS
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  36. Rodney Ramcharan, 2005. "Cataclysms and Currencies; Does the Exchange Rate Regime Matter for Real Shocks?," IMF Working Papers 05/85, International Monetary Fund.
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