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Monetary Policy Rules for Managing Aid Surges in Africa

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

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.

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Paper provided by International Monetary Fund in its series IMF Working Papers with number 07/180.

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Length: 40
Date of creation: 01 Jul 2007
Date of revision:
Handle: RePEc:imf:imfwpa:07/180
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  1. 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.
  2. Sanjeev Gupta & Catherine A. Pattillo & Smita Wagh, 2006. "Are Donor Countries Giving More or Less Aid?," IMF Working Papers 06/1, International Monetary Fund.
  3. Edward F. Buffie & Stephen A. O'Connell & Catherine A. Pattillo & Christopher Adam, 2007. "Monetary Policy Rules for Managing Aid Surges in Africa," IMF Working Papers 07/180, International Monetary Fund.
  4. Catherine A. Pattillo & Stephen A. O'Connell & Christopher Adam & Edward F. Buffie, 2004. "Exchange Rate Policy and the Management of official and Private Capital Flows in Africa," IMF Working Papers 04/216, International Monetary Fund.
  5. Edward F. Buffie, 2003. "Tight Money, Real Interest Rates, and Inflation in Sub-Saharan Africa," IMF Staff Papers, Palgrave Macmillan, vol. 50(1), pages 6.
  6. 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.
  7. Buffie, Edward F. & O'Connell, Stephen A. & Adam, Christopher, 2010. "Fiscal inertia, donor credibility, and the monetary management of aid surges," Journal of Development Economics, Elsevier, vol. 93(2), pages 287-298, November.
  8. Reinhart, Carmen & Calvo, Guillermo & Vegh, Carlos, 1994. "Targeting the real exchange rate," MPRA Paper 13765, University Library of Munich, Germany.
  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. Edward Buffie & Christopher Adam & Stephen O'Connell & Catherine Patillo, 2006. "Riding the Wave: Monetary Responses to Aid Surges in Low-Income Countries," CSAE Working Paper Series 2006-04, Centre for the Study of African Economies, University of Oxford.
  11. 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, 03.
  12. 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, 08.
  13. 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.
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