Policy Responses to Aid Surges in Countries with Limited International Capital Mobility: The Role of the Exchange Rate Regime

By Andrew Berg, Rafael A Portillo, Luis-Felipe Zanna

January 30, 2014

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Format: Chicago

Andrew Berg, Rafael A Portillo, and Luis-Felipe Zanna. Policy Responses to Aid Surges in Countries with Limited International Capital Mobility: The Role of the Exchange Rate Regime, (USA: International Monetary Fund, 2014) accessed December 3, 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

We study the role of the exchange rate regime, reserve accumulation, and sterilization policies in the macroeconomics of aid surges. Absent sterilization, a peg allows for almost full aid absorption — an increase in the current account deficit net of aid—delivering the same effects as those of a flexible regime but with a necessary increase in inflation. Regardless of the regime, policies that limit absorption—and result in large accumulation of reserves—are welfare reducing: they help reduce the real appreciation (and inflation under the peg), but at the expense of reducing private consumption and investment, and therefore medium-term growth.

Subject: Central banks, Conventional peg, Exchange rate arrangements, Exchange rate flexibility, Foreign exchange, Reserves accumulation, Sterilization

Keywords: Africa, Aid, Appreciation pressure, Central bank, Conventional peg, Depreciation rate, Exchange rate, Exchange rate arrangements, Exchange rate flexibility, Exchange Rate Regimes, Expenditure switching, Flexible exchange rate regime, Inflation expectation, Managed float, Managed float regime, Nominal exchange rate, Nominal interest rate, Open economy, Real gross domestic product, Reserve Accumulation Policies, Reserve holding, Reserves accumulation, Sterilization, Sterilization Policies, Sub-Saharan Africa, Transfer Problem, Transmission mechanism, WP

Publication Details

Pages:

41
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 2014/018
Stock No:

WPIEA2014018
ISBN:

9781484397008
ISSN:

1018-5941

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