Aid Volatility and Poverty Traps

27 Pages Posted: 14 Sep 2007 Last revised: 4 Aug 2013

See all articles by Pierre-Richard Agenor

Pierre-Richard Agenor

University of Manchester - School of Social Sciences

Joshua Aizenman

National Bureau of Economic Research (NBER)

Date Written: September 2007

Abstract

This paper studies the impact of aid volatility in a two-period model where production may occur with either a traditional or a modern technology. Public spending is productive and "time to build" requires expenditure in both periods for the modern technology to be used. The possibility of a poverty trap induced by high aid volatility is first examined in a benchmark case where taxation is absent. The analysis is then extended to account for self insurance (taking the form of a first-period contingency fund) financed through taxation. An increase in aid volatility is shown to raise the optimal contingency fund. But if future aid also depends on the size of the contingency fund (as a result of a moral hazard effect on donors' behavior), the optimal policy may entail no self insurance.

Suggested Citation

Agenor, Pierre-Richard and Aizenman, Joshua, Aid Volatility and Poverty Traps (September 2007). NBER Working Paper No. w13400. Available at SSRN: https://ssrn.com/abstract=1014347

Pierre-Richard Agenor (Contact Author)

University of Manchester - School of Social Sciences ( email )

Oxford Road
Manchester, M13 9PL
United Kingdom

Joshua Aizenman

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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