Monetary Policy Rules for Managing Aid Surges in Africa
WEF Working Paper No. 0016
36 Pages Posted: 2 Nov 2007
Date Written: February 2007
We examine the properties of alternative monetary policy rules in response to large aid surges in low-income countries characterized by incomplete capital market integration and currency substitution. Using a dynamic stochastic general equilibrium model, we show that simple monetary rules that stabilize the path of expected future seigniorage for a given aid flow have attractive properties relative to a range of conventional alternatives including those involving heavy reliance on bond sterilization or a commitment to a pure exchange rate float. These simple rules, which are shown to be robust across a range of fiscal responses to aid inflows, appear to be consistent with actual responses to recent aid surges in a range of post-stabilization countries in Sub-Saharan Africa.
Keywords: monetary policy, currency substitution, aid, Africa, DSGE models,
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