The Short-Run Macroeconomics of Aid Inflows: Understanding the Interaction of Fiscal and Reserve Policy
IMF Working Papers, March 1, 2010
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Bibliographic details
- Authors: Luis-Felipe Zanna, Andrew Berg, Tokhir N Mirzoev, Rafael A Portillo
- Published: March 1, 2010
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9781451982091.001
Model and approach
- Develops a tractable open-economy new-Keynesian model with two sectors to analyze the short-term effects of aid-financed fiscal expansions.
- Distinguishes between:
- "Spending the aid" — under the control of fiscal authorities.
- "Absorbing the aid" — using the aid to finance a higher current account deficit, influenced by the central bank’s reserves policy when access to international capital markets is limited.
- Notes that the standard treatment of the transfer problem implicitly assumes spending equals absorption; this model relaxes that assumption to study policy mix interactions.
Key findings
- A policy mix that results in spending but not absorbing the aid:
- Generates demand pressures.
- Results in an increase in real interest rates.
- Can lead to a temporary real depreciation if demand pressures are strong enough to threaten external balance.
- Features of low income countries amplify outcomes:
- Limited participation in domestic financial markets makes a real depreciation more likely by amplifying demand pressures when aid is spent but not absorbed.
- Empirical relevance:
- Model results can help understand the recent experience of Uganda, which experienced an increase in government spending following a surge in aid yet saw a real depreciation and an increase in real interest rates.
Policy implications and mechanisms
- Interaction of fiscal policy (spending decisions) and reserve/central bank policy (absorption via current account and reserves) is crucial for short-run macroeconomic outcomes after aid inflows.
- When access to international capital markets is limited, central bank reserves policy becomes a key determinant of whether aid is absorbed or not.
- Policy mixes that ignore the distinction between spending and absorption risk unintended increases in real interest rates and real exchange rate volatility.
Publication and metadata
- Authors: Luis-Felipe Zanna, Andrew Berg, Tokhir N Mirzoev, Rafael A Portillo
- Date: March 1, 2010
- Series: Working Paper No. 2010/065
- Issue: 065
- Volume: 2010
- Pages: 46
- DOI: https://doi.org/10.5089/9781451982091.001
- Stock No: WPIEA2010065
- ISBN: 9781451982091
- ISSN: 1018-5941
- Subjects: Consumption, Expenditure, Labor supply, Real exchange rates, Real interest rates
- Keywords: central bank, exchange rate, WP
IMF Working Paper: "The Short-Run Macroeconomics of Aid Inflows: Understanding the Interaction of Fiscal and Reserve Policy" — Luis-Felipe Zanna, Andrew Berg, Tokhir N Mirzoev, Rafael A Portillo, March 1, 2010.