Aid Volatility and Dutch Disease: Is There a Role for Macroeconomic Policies?

65 Pages Posted: 26 Jul 2006

See all articles by Alessandro Prati

Alessandro Prati

International Monetary Fund (IMF) - Research Department, Deceased

Thierry Tressel

International Monetary Fund (IMF) - Research Department

Date Written: June 2006

Abstract

This paper studies how macroeconomic policies can help offset two unintended and undesirable features of foreign aid: its volatility and Dutch disease. We present evidence that aid volatility augments trade balance volatility and that foreign aid, with the important exception of years of adverse shocks, depresses exports. We also find that these effects can be mitigated through changes in net domestic assets of the central bank-a variable that reflects both monetary and fiscal policy. To characterize the optimal policy, we develop a general equilibrium model in which the capital account is closed and aid influences productivity growth through positive (public expenditure) and negative (Dutch disease) externalities. In this setting, macroeconomic policies permanently affect real variables and can improve welfare if donors do not distribute foreign aid optimally over time.

Keywords: Aid effectiveness, monetary policy, real exchange rate, Dutch disease

JEL Classification: O11, O4, O23, E5, F35

Suggested Citation

Prati, Alessandro and Tressel, Thierry, Aid Volatility and Dutch Disease: Is There a Role for Macroeconomic Policies? (June 2006). IMF Working Paper, Vol. , pp. 1-65, 2006. Available at SSRN: https://ssrn.com/abstract=920237

Alessandro Prati (Contact Author)

International Monetary Fund (IMF) - Research Department, Deceased ( email )

Thierry Tressel

International Monetary Fund (IMF) - Research Department ( email )

700 19th Street NW
Washington, DC 20431
United States

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