Foreign Aid and Real Exchange Rate Adjustments in a Financially Constrained Dependent Economy

47 Pages Posted: 12 Sep 2008

See all articles by Serpil Tekin

Serpil Tekin

University of Washington

Stephen J. Turnovsky

University of Washington - Institute for Economic Research; CESifo (Center for Economic Studies and Ifo Institute)

Valerie Cerra

International Monetary Fund (IMF)

Date Written: August 2008

Abstract

A dynamic dependent-economy model is developed to investigate the role of the real exchange rate in determining the effects of foreign aid. If capital is perfectly mobile between sectors, untied aid has no longrun impact on the real exchange rate. A decline in the traded sector occurs because aid, being denominated in traded output, substitutes for exports in financing imports. While untied aid causes short-run real exchange appreciation, this response is very temporary and negligibly small. Tied aid, by influencing sectoral productivity, does generate permanent relative price effects. The analysis, which employs extensive numerical simulations, emphasizes the tradeoffs between real exchange adjustments, long-run capital accumulation, and economic welfare, associated with alternative forms of foreign aid.

Keywords: Working Paper, Aid flows, Real effective exchange rates, Imports, Fiscal policy, External debt, Capital accumulation, Trade, Economic models

Suggested Citation

Tekin, Serpil and Turnovsky, Stephen J. and Cerra, Valerie, Foreign Aid and Real Exchange Rate Adjustments in a Financially Constrained Dependent Economy (August 2008). IMF Working Paper No. 08/204, Available at SSRN: https://ssrn.com/abstract=1266537

Serpil Tekin (Contact Author)

University of Washington ( email )

Seattle, WA 98195
United States

Stephen J. Turnovsky

University of Washington - Institute for Economic Research ( email )

Seattle, WA 98195
United States
206-685-8028 (Phone)
206-543-5955 (Fax)

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany

Valerie Cerra

International Monetary Fund (IMF) ( email )

700 19th Street NW
Washington, DC 20431
United States
202-623-8596 (Phone)

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