On the Potential of Foreign Aid as Insurance
20 Pages Posted: 20 Jul 2006
Date Written: November 2005
In this paper, we quantify foreign aid's potential as an insurance mechanism against macroeconomic shocks. Within a dynamic model of aid flows between two endowment economies, we show that at least three fourths of the large welfare costs of macroeconomic fluctuations in poor countries could be alleviated by a simple reallocation of aid flows across time. In developing countries subject to persistent macroeconomic shocks, the resulting welfare improvement is of first-order magnitude.
Keywords: Macroeconomic fluctuations, Welfare, Foreign aid, Consumption smoothing
JEL Classification: F35, E32, E60
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