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Monetary Policy Rules for Managing Aid Surges in Africa

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  • Edward F Buffie
  • Stephen A. O'Connell
  • Catherine A Pattillo
  • Christopher S Adam

Abstract

Since the turn of the century, aid flows to Africa have increased on average and become more volatile. As a result, policymakers, particularly in post-stabilization countries where inflation has only recently been brought under control, have been increasingly preoccupied with how best to deploy the available instruments of monetary policy without yielding on hard-won inflation gains. We use a stochastic simulation model, in which private sector currency substitution effects play a central role, to examine the properties of alternative monetary and fiscal policy strategies in the face of volatile aid flows. We show that simple monetary rules, specifically an (unsterilized) exchange rate crawl and a 'reserve buffer plus float'-under which the authorities set a time-varying reserve target corresponding to the unspent portion of aid financing and allow the exchange rate to float freely once this reserve target is satisfied-have attractive properties relative to a range of alternative strategies including those involving heavy reliance on bond sterilization or a commitment to a 'pure' exchange rate float.

Suggested Citation

  • Edward F Buffie & Stephen A. O'Connell & Catherine A Pattillo & Christopher S Adam, 2007. "Monetary Policy Rules for Managing Aid Surges in Africa," IMF Working Papers 07/180, International Monetary Fund.
  • Handle: RePEc:imf:imfwpa:07/180
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    References listed on IDEAS

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    1. Christopher Adam & Stephen O'Connell & Edward Buffie & Catherine Pattillo, 2009. "Monetary Policy Rules for Managing Aid Surges in Africa," Review of Development Economics, Wiley Blackwell, vol. 13(s1), pages 464-490, August.
    2. Roemer, Michael, 1989. "The macroeconomics of counterpart funds revisited," World Development, Elsevier, vol. 17(6), pages 795-807, June.
    3. 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.
    4. Buffie, Edward & Adam, Christopher & O'Connell, Stephen & Pattillo, Catherine, 2008. "Riding the wave: Monetary responses to aid surges in low-income countries," European Economic Review, Elsevier, vol. 52(8), pages 1378-1395, November.
    5. Bulír, Ales & Hamann, A. Javier, 2008. "Volatility of Development Aid: From the Frying Pan into the Fire?," World Development, Elsevier, vol. 36(10), pages 2048-2066, October.
    6. Martin Brownbridge & Emmanuel Tumusiime-Mutebile, 2007. "Aid and Fiscal Deficits: Lessons from Uganda on the Implications for Macroeconomic Management and Fiscal Sustainability," Development Policy Review, Overseas Development Institute, vol. 25(2), pages 193-213, March.
    7. Sanjeev Gupta & Catherine Pattillo & Smita Wagh, 2006. "Are Donor Countries Giving More or Less Aid?," Review of Development Economics, Wiley Blackwell, vol. 10(3), pages 535-552, August.
    8. C. L. Ramirez-Rojas, 1985. "Currency Substitution in Argentina, Mexico, and Uruguay (Substitution de monnaie en Argentine, au Mexique et en Uruguay) (Sustitución de moneda en Argentina, México y Uruguay)," IMF Staff Papers, Palgrave Macmillan, vol. 32(4), pages 629-667, December.
    9. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
    10. Sanjeev Gupta & Catherine A Pattillo & Smita Wagh, 2006. "Are Donor Countries Giving More or Less Aid?," IMF Working Papers 06/1, International Monetary Fund.
    11. Edward Buffie & Christopher Adam & Stephen O'Connell & Catherine Pattillo, 2004. "Exchange Rate Policy and the Management of Official and Private Capital Flows in Africa," IMF Staff Papers, Palgrave Macmillan, vol. 51(s1), pages 126-160, June.
    12. Edward F. Buffie, 2003. "Tight Money, Real Interest Rates, and Inflation in Sub-Saharan Africa," IMF Staff Papers, Palgrave Macmillan, vol. 50(1), pages 1-6.
    13. 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.
    14. Buffie, Edward & Adam, Christopher & O'Connell, Stephen & Pattillo, Catherine, 2008. "Riding the wave: Monetary responses to aid surges in low-income countries," European Economic Review, Elsevier, vol. 52(8), pages 1378-1395, November.
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    Cited by:

    1. Christopher Adam & Stephen O'Connell & Edward Buffie & Catherine Pattillo, 2009. "Monetary Policy Rules for Managing Aid Surges in Africa," Review of Development Economics, Wiley Blackwell, vol. 13(s1), pages 464-490, August.
    2. Fischer, A.M., 2017. "Dilemmas of externally financing domestic expenditures: Rethinking the political economy of aid and social protection through the monetary transformation dilemma," ISS Working Papers - General Series 629, International Institute of Social Studies of Erasmus University Rotterdam (ISS), The Hague.
    3. SENBETA, Sisay Regassa, 2013. "Foreign exchange constraints and macroeconomic dynamics in a small open economy," Working Papers 2013023, University of Antwerp, Faculty of Applied Economics.
    4. Christopher Adam & Stephen O’Connell & Edward Buffie, 2009. "Aid Volatility, Monetary Policy Rules and the Capital Account in African Economies," Chapters,in: Monetary Policy Frameworks for Emerging Markets, chapter 13 Edward Elgar Publishing.
    5. Eric Gabin Kilama, 2014. "Recipients aid absorption in the new development cooperation landscape," Economics Bulletin, AccessEcon, vol. 34(3), pages 1929-1944.
    6. Chance Mwabutwa & Nicola Viegi & Manoel Bittencourt, 2012. "Monetary Policy Response to Capital Inflows in Form of Foreign Aid in Malawi," Working Papers 201232, University of Pretoria, Department of Economics.
    7. Berg, Andrew & Portillo, Rafael & Zanna, Luis-Felipe, 2015. "Policy Responses to Aid Surges in Countries with Limited International Capital Mobility: The Role of the Exchange Rate Regime," World Development, Elsevier, vol. 69(C), pages 116-129.
    8. Buffie, Edward & Adam, Christopher & O'Connell, Stephen & Pattillo, Catherine, 2008. "Riding the wave: Monetary responses to aid surges in low-income countries," European Economic Review, Elsevier, vol. 52(8), pages 1378-1395, November.
    9. Andrew Berg & Filiz D Unsal & Rafael A Portillo, 2010. "On the Optimal Adherence to Money Targets in a New-Keynesian Framework; An Application to Low-Income Countries," IMF Working Papers 10/134, International Monetary Fund.
    10. Clemens Breisinger & Xinshen Diao & Rainer Schweickert & Manfred Wiebelt, 2010. "Managing Future Oil Revenues in Ghana: An Assessment of Alternative Allocation Options," African Development Review, African Development Bank, vol. 22(2), pages 303-315.
    11. Senbeta, Sisay, 2011. "A small open economy New Keynesian model for a foreign exchange constrained economy," MPRA Paper 29996, University Library of Munich, Germany.
    12. Senbeta, Sisay, 2011. "How applicable are the new keynesian DSGE models to a typical low-income economy?," MPRA Paper 30931, University Library of Munich, Germany.
    13. SENBETA, Sisay Regassa, 2012. "How important are external shocks in explaining growth in Sub-Saharan Africa? Evidence from a Bayesian VAR," Working Papers 2012010, University of Antwerp, Faculty of Applied Economics.
    14. Jan Kees Martijn & Markus Berndt & Abu Shonchoy & Paolo Dudine, 2008. "The Spending and Absorption of Aid in PRGF Supported Programs," IMF Working Papers 08/237, International Monetary Fund.
    15. Mumtaz Hussain & Andrew Berg & Shekhar Aiyar, 2009. "The Macroeconomic Management of Increased Aid: Policy Lessons from Recent Experience," Review of Development Economics, Wiley Blackwell, vol. 13(s1), pages 491-509, August.
    16. Emmanuel Frot & Javier Santiso, 2008. "Development Aid and Portfolio Funds: Trends, Volatility and Fragmentation," OECD Development Centre Working Papers 275, OECD Publishing.
    17. KAMGNA, Severin Yves & Ndambendia, Houdou, 2008. "Excès de liquidité systémique et effectivité de la politique monétaire : cas des pays de la CEMAC
      [Excess liquidity and monetary policy effectiveness: The case of CEMAC countries]
      ," MPRA Paper 9599, University Library of Munich, Germany.
    18. Ruslan Aliyev, 2012. "Monetary Policy in Resource-Rich Developing Economies," CERGE-EI Working Papers wp466, The Center for Economic Research and Graduate Education - Economics Institute, Prague.
    19. SENBETA, Sisay Regassa, 2011. "A small open economy new Keynesian DSGE model for a foreign exchange constrained economy," Working Papers 2011004, University of Antwerp, Faculty of Applied Economics.
    20. Stephen A. O'Connell, 2011. "Towards a Rule-based Approach to Monetary Policy Evaluation in Sub-Saharan Africa-super- †," Journal of African Economies, Centre for the Study of African Economies (CSAE), vol. 20(suppl_2), pages -66, May.

    More about this item

    Keywords

    Africa; Development assistance; Economic models; Monetary policy; Aid volatility; stochastic simulation models; exchange rate; inflation; foreign exchange; real exchange rate;

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