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Aid Volatility and Dutch Disease: Is There a Role for Macroeconomic Policies?

Author/Editor: Prati, Alessandro | Tressel, Thierry
Authorized for Distribution: June 1, 2006
Electronic Access: Free Full Text (PDF file size is 839KB)
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Disclaimer: This Working Paper should not be reported as representing the views of the IMF. The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate.

Summary: 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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Series: Working Paper No. 06/145
Subject(s): Development assistance | Monetary policy | Real effective exchange rates | Balance of trade
Author's keyword(s): Aid effectiveness | monetary policy | real exchange rate | Dutch disease
 
English  
    Published:   June 1, 2006        
    ISBN/ISSN:   0 / 1934-7073   Format:   Paper
    Stock No:   WPIEA2006145   Pages:   65
    Price:   US$15.00 (Academic Rate: US$15.00 )
       
     
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