Aid Volatility and Dutch Disease: Is There a Role for Macroeconomic Policies?

June 1, 2006

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Format: Chicago

Thierry Tressel, and Alessandro Prati. Aid Volatility and Dutch Disease: Is There a Role for Macroeconomic Policies?, (USA: International Monetary Fund, 2006) accessed November 21, 2024

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

This paper studies how macroeconomic policies can help offset two unintended and undesirable features of foreign aid: its volatility and Dutch disease. We present evidence that aid volatility augments trade balance volatility and that foreign aid, with the important exception of years of adverse shocks, depresses exports. We also find that these effects can be mitigated through changes in net domestic assets of the central bank-a variable that reflects both monetary and fiscal policy. To characterize the optimal policy, we develop a general equilibrium model in which the capital account is closed and aid influences productivity growth through positive (public expenditure) and negative (Dutch disease) externalities. In this setting, macroeconomic policies permanently affect real variables and can improve welfare if donors do not distribute foreign aid optimally over time.

Subject: Exports, Foreign aid, International reserves, Real exchange rates, Trade balance

Keywords: Dutch disease, Monetary policy, Price index, WP

Publication Details

Pages:

65
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 2006/145
Stock No:

WPIEA2006145
ISBN:

9781451864052
ISSN:

1018-5941

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