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The Macroeconomics of Medium-Term Aid Scaling-Up Scenarios

Author/Editor: Berg, Andrew | Gottschalk, Jan | Portillo, Rafael | Zanna, Luis-Felipe
Authorized for Distribution: July 1, 2010
Electronic Access: Free Full Text (PDF file size is 1,114KB)
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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: We develop a model to analyze the macroeconomic effects of a scaling-up of aid and assess the implications of different policy responses. The model features key structural characteristics of low-income countries, including varying degrees of public investment efficiency and a learning-by-doing (LBD) externality that captures Dutch disease effects. On the policy front, it distinguishes between spending the aid, which is controlled by the fiscal authority, and absorbing the aid - financing a higher current account deficit - which is influenced by the central bank's reserve accumulation policies. We calibrate the model to Uganda and run several experiments. We find that a policy mix that results in full spending and absorption of aid can generate temporary demand and real exchange rate appreciation pressures, but also have a positive effect on real GDP in the medium term, through higher public capital. Full spending with partial absorption, on the other hand, may stem appreciation pressures but can also induce adverse medium-term real GDP effects, through private sector crowding out. When aid is very inefficiently invested and there are strong LBD externalities, aid can be harmful, and partial absorption policies may be justified. But in this case, a welfare improving solution is to defer spending or - even better if possible - raise its efficiency.
 
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Series: Working Paper No. 10/160
Subject(s): Aid flows | Economic assistance | Economic models | Exchange rate appreciation | Gross domestic product | Low-income developing countries | Public investment | Reserves accumulation | Uganda
Author's keyword(s): Aid; Africa; Dutch Disease; Fiscal Policy; Monetary Policy; Public Investment; Real Exchange Rate; Transfer problem.
 
English  
    Published:   July 1, 2010        
            Format:   Paper
    Stock No:   WPIEA2010160   Pages:   45
    Price:   US$18.00
       
     
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