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The Short-Run Macroeconomic Impact of Foreign Aid to Small States: An Agnostic Timeseries Analysis

  • Hansen, Henrik
  • Headey, Derek

This study econometrically evaluates the short-run impact of aid in small developing countries (SDCs) by applying a VAR model to study aid's impact on 'absorption' (increasing import demand) and 'spending' (increased domestic demand) across countries. Whilst our approach allows parameters to vary across countries, the focus is on average country effects and differential effects within certain subgroups of countries. In particular, we find substantial differences between 'aid-dependent' SDCs and other SDCs which are more dependent on mineral resources and financial services. In the latter group, aid seems to be neither absorbed nor spent in any systematic fashion. But in the aid-dependent SDCs, aid receipts seem to be used more in the textbook 'absorb and spend' fashion.

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File URL: http://www.wider.unu.edu/stc/repec/pdfs/rp2007/rp2007-38.pdf
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Paper provided by World Institute for Development Economic Research (UNU-WIDER) in its series Working Paper Series with number UNU-WIDER Research Paper RP2007/38.

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Length: 24 pages
Date of creation: 2007
Date of revision:
Handle: RePEc:unu:wpaper:rp2007-38
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  1. Stephane Pallage & Michel Robe, 1998. "Foreign Aid and the Business Cycle," Cahiers de recherche CREFE / CREFE Working Papers 63, CREFE, Université du Québec à Montréal.
  2. A. Javier Hamann & Ales Bulir, 2006. "Volatility of Development Aid; From the Frying Pan Into the Fire?," IMF Working Papers 06/65, International Monetary Fund.
  3. Christopher A. Sims & Tao Zha, 1994. "Error Bands for Impulse Responses," Cowles Foundation Discussion Papers 1085, Cowles Foundation for Research in Economics, Yale University.
  4. Armstrong, H. & De Kervenoael, R. J. & Li, X. & Read, R., 1998. "A comparison of the economic performance of different micro-states, and between micro-states and larger countries," World Development, Elsevier, vol. 26(4), pages 639-656, April.
  5. Shekhar Aiyar & Ummul Hasanath Ruthbah, 2008. "Where Did All the Aid Go? An Empirical Analysis of Absorption and Spending," IMF Working Papers 08/34, International Monetary Fund.
  6. Peter S. Heller & Sanjeev Gupta, 2002. "Challenges in Expanding Development Assistance," IMF Policy Discussion Papers 02/5, International Monetary Fund.
  7. Pesaran, M. Hashem & Smith, Ron, 1995. "Estimating long-run relationships from dynamic heterogeneous panels," Journal of Econometrics, Elsevier, vol. 68(1), pages 79-113, July.
  8. Easterly, William & Kraay, Aart, 2000. "Small States, Small Problems? Income, Growth, and Volatility in Small States," World Development, Elsevier, vol. 28(11), pages 2013-2027, November.
  9. Tony Killick & Mick Foster, 2007. "The Macroeconomics of Doubling Aid to Africa and the Centrality of the Supply Side," Development Policy Review, Overseas Development Institute, vol. 25(2), pages 167-192, 03.
  10. Milner, Chris & Westaway, Tony, 1993. "Country size and the medium-term growth process: Some cross-country evidence," World Development, Elsevier, vol. 21(2), pages 203-211, February.
  11. Kajal Lahiri, 2005. "Analysis of Panel Data," American Journal of Agricultural Economics, Agricultural and Applied Economics Association, vol. 87(4), pages 1093-1095.
  12. Harvey W. Armstrong & Robert Read, 2002. "The phantom of liberty?: economic growth and the vulnerability of small states," Journal of International Development, John Wiley & Sons, Ltd., vol. 14(4), pages 435-458.
  13. Barten, A. P., 1969. "Maximum likelihood estimation of a complete system of demand equations," European Economic Review, Elsevier, vol. 1(1), pages 7-73.
  14. Osei, Robert & Morrissey, Oliver & Lloyd, Tim, 2005. "The Fiscal Effects of Aid in Ghana," Working Paper Series RP2005/61, World Institute for Development Economic Research (UNU-WIDER).
  15. Ale Bulir & A. Javier Hamann, 2003. "Aid Volatility: An Empirical Assessment," IMF Staff Papers, Palgrave Macmillan, vol. 50(1), pages 4.
  16. Streeten, Paul, 1993. "The special problems of small countries," World Development, Elsevier, vol. 21(2), pages 197-202, February.
  17. Briguglio, Lino, 1995. "Small island developing states and their economic vulnerabilities," World Development, Elsevier, vol. 23(9), pages 1615-1632, September.
  18. Andrew Berg & Mumtaz Hussain & Shaun K. Roache & Amber Mahone & Tokhir N. Mirzoev & Shekhar Aiyar, 2007. "The Macroeconomics of Scaling Up Aid; Lessons from Recent Experience," IMF Occasional Papers 253, International Monetary Fund.
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