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Policy Responses to Aid Surges in Countries with Limited International Capital Mobility: The Role of the Exchange Rate Regime

Author/Editor: Andrew Berg | Rafael A Portillo | Luis-Felipe Zanna
Authorized for Distribution: January 30, 2014
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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 study the role of the exchange rate regime, reserve accumulation, and sterilization policies in the macroeconomics of aid surges. Absent sterilization, a peg allows for almost full aid absorption — an increase in the current account deficit net of aid—delivering the same effects as those of a flexible regime but with a necessary increase in inflation. Regardless of the regime, policies that limit absorption—and result in large accumulation of reserves—are welfare reducing: they help reduce the real appreciation (and inflation under the peg), but at the expense of reducing private consumption and investment, and therefore medium-term growth.
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Series: Working Paper No. 14/18
Subject(s): Exchange rate regimes | Aid flows | Africa | Foreign exchange | Reserves accumulation | Central banks | Monetary policy | Fiscal policy | Economic models
    Published:   January 30, 2014        
    ISBN/ISSN:   9781484397008/1018-5941   Format:   Paper
    Stock No:   WPIEA2014018   Pages:   41
    Price:   US$18.00
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