Foreign Aid and Real Exchange Rate Adjustments in a Financially Constrained Dependent Economy

Author/Editor:

Stephen J. Turnovsky ; Serpil Tekin ; Valerie Cerra

Publication Date:

August 1, 2008

Electronic Access:

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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:

A dynamic dependent-economy model is developed to investigate the role of the real exchange rate in determining the effects of foreign aid. If capital is perfectly mobile between sectors, untied aid has no longrun impact on the real exchange rate. A decline in the traded sector occurs because aid, being denominated in traded output, substitutes for exports in financing imports. While untied aid causes short-run real exchange appreciation, this response is very temporary and negligibly small. Tied aid, by influencing sectoral productivity, does generate permanent relative price effects. The analysis, which employs extensive numerical simulations, emphasizes the tradeoffs between real exchange adjustments, long-run capital accumulation, and economic welfare, associated with alternative forms of foreign aid.

Series:

Working Paper No. 08/204

Subject:

Frequency:

Annually

English

Publication Date:

August 1, 2008

ISBN/ISSN:

9781451870626/1018-5941

Stock No:

WPIEA2008204

Price:

$18.00 (Academic Rate:$18.00)

Format:

Paper

Pages:

45

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