IMF Working Papers

Optimal Fiscal Spending and Reserve Accumulation Policies under Volatile Aid

By Ioana Moldovan, Shu-Chun Susan Yang, Luis-Felipe Zanna

June 11, 2019

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Ioana Moldovan, Shu-Chun Susan Yang, and Luis-Felipe Zanna. Optimal Fiscal Spending and Reserve Accumulation Policies under Volatile Aid, (USA: International Monetary Fund, 2019) accessed December 9, 2024

Disclaimer: IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.

Summary

This paper assesses the optimal setting of fiscal spending and foreign exchange rate intervention policies in response to volatile foreign aid, in a small open economy model that incorporates typical features of low-income countries. Within a class of policy rules, it jointly considers the optimal aid spending and international reserve accumulation policies. The results show that it is optimal to adjust government spending gradually in response to unpredictable fluctuations in aid, while partially accumulating foreign exchange reserves to offset Dutch disease effects. Also, allocating relatively more of the government spending to productive public investment, and less to government consumption, is welfare improving.

Subject: Central banks, Consumption, Expenditure, National accounts, Private consumption, Public investment spending, Reserves accumulation

Keywords: Africa, Aid, Aid spending, CES consumption basket, Consumption, Consumption decision, Consumption level, Depreciation rate, Fiscal policy, Foreign exchange intervention, Goods sector, Government spending, Gradual aid spending, Gradual spending, Hand-to-mouth consumer, Impulse response, Low-income countries, Optimal policy, Private consumption, Public goods, Public investment spending, Reserve accumulation policy, Reserves accumulation, Spending of aid, Spending policy, Spending process, Sub-Saharan Africa, Welfare change, WP

Publication Details

  • Pages:

    45

  • Volume:

    ---

  • DOI:

    ---

  • Issue:

    ---

  • Series:

    Working Paper No. 2019/126

  • Stock No:

    WPIEA2019126

  • ISBN:

    9781498312110

  • ISSN:

    1018-5941