Monetary Policy Rules for Managing Aid Surges in Africa
IMF Working Papers, July 1, 2007
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- Monetary Policy Rules for Managing Aid Surges in Africa
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Bibliographic details
- Authors: Edward F Buffie, Stephen A. O'Connell, Catherine A Pattillo, Christopher S Adam
- Published: July 1, 2007
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9781451867442.001
Summary and context
- Since the turn of the century, aid flows to Africa have increased on average and become more volatile.
- Policymakers, particularly in post-stabilization countries where inflation has only recently been brought under control, face trade-offs in deploying monetary instruments without yielding on hard-won inflation gains.
- The paper uses a stochastic simulation model, in which private sector currency substitution effects play a central role, to examine the properties of alternative monetary and fiscal policy strategies in the face of volatile aid flows.
Methodology
- Stochastic simulation model emphasizing private sector currency substitution effects.
- Comparison of alternative monetary and fiscal policy strategies under volatile aid inflows.
Key findings
- Simple monetary rules perform well relative to more complex strategies in the face of aid volatility.
- Two specific rules with attractive properties:
- An (unsterilized) exchange rate crawl.
- A "reserve buffer plus float" rule, under which the authorities set a time-varying reserve target corresponding to the unspent portion of aid financing and allow the exchange rate to float freely once this reserve target is satisfied.
- These rules are attractive relative to a range of alternative strategies including those involving heavy reliance on bond sterilization or a commitment to a "pure" exchange rate float.
Policy implications and recommendations
- Consider adopting simple, rule-based monetary approaches (e.g., unsterilized exchange rate crawl; reserve buffer plus float) when managing volatile aid inflows.
- Avoid heavy reliance on bond sterilization as the primary response to aid surges.
- Allowing conditional exchange rate flexibility (after reserve targets are met) can provide better outcomes than committing to a pure float or to persistent sterilization.
Subjects and keywords
- Subject: Currencies, Exchange rates, Expenditure, Inflation, Real exchange rates
- Keywords: central bank, exchange rate, fiscal policy, WP
Disclaimer from the paper
- 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.
Working Paper No. 2007/180, IMF.