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Monetary Policy Response to Capital Inflows in Form of Foreign Aid in Malawi


  • Chance Mwabutwa

    () (Department of Economics, University of Pretoria)

  • Nicola Viegi

    () (Department of Economics, University of Pretoria)

  • Manoel Bittencourt

    () (Department of Economics, University of Pretoria)


This paper estimates the Bayesian dynamic stochastic general equilibrium (DSGE) model and uses the model to account for the short-run monetary policy response to increased aid inflows in Malawi. The estimates reveal that the monetary authorities reacted to increased foreign aid inflows the same way as was experienced in other African countries. The model also suggests that there was non-existence of the threats of the ‘Dutch Disease’ in contrast to what was found in Mozambique. The country can continue to receive aid by targeting the supply side of the economy with an aim of improving the competiveness of the export sector. Evidently, the conduct of monetary policy performs better under the assumption of full accessibility of financial assets. In addition, the impact of aid inflows on depreciation and inflation are much smaller when monetary authorities indulge in money targeting other than following the Taylor rule and incomplete sterilisation. On the small note, the study suggests that actual spending of aid should be aligned with the actual absorption of increased aid. Nevertheless, the outcome of the aid effects has been clouded out by the limitation of the exchange rate management in Malawi.

Suggested Citation

  • 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.
  • Handle: RePEc:pre:wpaper:201232

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    References listed on IDEAS

    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.
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    18. Manoel Bittencourt & Chance Mwabutwa & Nicola Viegi, 2012. "Financial Reforms and Consumption Behaviour in Malawi," Working Papers 201210, University of Pretoria, Department of Economics.
    19. Luis-Felipe Zanna & Andrew Berg & Tokhir N Mirzoev & Rafael A Portillo, 2010. "The Short-Run Macroeconomics of Aid Inflows; Understanding the Interaction of Fiscal and Reserve Policy," IMF Working Papers 10/65, International Monetary Fund.
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    More about this item


    Taylor Rule; DSGE Model; Rule-of-Thumb; Spending; Absorption; Foreign Exchange Rate; Bayesian Methods;

    JEL classification:

    • C11 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Bayesian Analysis: General
    • C13 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Estimation: General
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy
    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F35 - International Economics - - International Finance - - - Foreign Aid

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