The Macroeconomics of Medium-Term Aid Scaling-Up Scenarios

46 Pages Posted: 19 Jul 2010

See all articles by Andrew Berg

Andrew Berg

International Monetary Fund (IMF) - Developing Country Studies Division

Jan Gottschalk

International Monetary Fund (IMF) - Policy Development and Review Department

Rafael Portillo

International Monetary Fund (IMF)

Luis-Felipe Zanna

International Monetary Fund (IMF)

Date Written: July 2010

Abstract

We develop a model to analyze the macroeconomic effects of a scaling-up of aid and assess the implications of different policy responses. The model features key structural characteristics of low-income countries, including varying degrees of public investment efficiency and a learning-by-doing (LBD) externality that captures Dutch disease effects. On the policy front, it distinguishes between spending the aid, which is controlled by the fiscal authority, and absorbing the aid - financing a higher current account deficit - which is influenced by the central bank's reserve accumulation policies. We calibrate the model to Uganda and run several experiments. We find that a policy mix that results in full spending and absorption of aid can generate temporary demand and real exchange rate appreciation pressures, but also have a positive effect on real GDP in the medium term, through higher public capital. Full spending with partial absorption, on the other hand, may stem appreciation pressures but can also induce adverse medium-term real GDP effects, through private sector crowding out. When aid is very inefficiently invested and there are strong LBD externalities, aid can be harmful, and partial absorption policies may be justified. But in this case, a welfare improving solution is to defer spending or - even better if possible - raise its efficiency.

Suggested Citation

Berg, Andrew and Gottschalk, Jan and Portillo, Rafael and Zanna, Luis-Felipe, The Macroeconomics of Medium-Term Aid Scaling-Up Scenarios (July 2010). IMF Working Papers, Vol. , pp. 1-45, 2010. Available at SSRN: https://ssrn.com/abstract=1641011

Andrew Berg

International Monetary Fund (IMF) - Developing Country Studies Division ( email )

700 19th Street NW
Washington, DC 20431
United States
202-623-8843 (Phone)
202-589-8843 (Fax)

Jan Gottschalk (Contact Author)

International Monetary Fund (IMF) - Policy Development and Review Department ( email )

700 19th St. NW
Washington, DC 20431
United States

Rafael Portillo

International Monetary Fund (IMF) ( email )

700 19th Street, N.W.
Washington, DC 20431
United States

Luis-Felipe Zanna

International Monetary Fund (IMF) ( email )

700 19th Street, N.W.
Washington, DC 20431
United States

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