The Macroeconomics of Scaling Up Aid: Lessons from Recent Experience
Occasional Papers, March 23, 2007
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Bibliographic details
- Authors: Andrew Berg, Mumtaz Hussain, Shaun K. Roache, Amber A Mahone, Tokhir N Mirzoev, Shekhar Aiyar
- Published: March 23, 2007
- Series: Occasional Papers
- DOI: https://doi.org/10.5089/9781589065918.084
Study focus and framework
- Analyzes key issues associated with large increases in aid: absorptive capacity, Dutch disease, and inflation.
- Develops a framework that emphasizes the different roles of monetary and fiscal policy.
- Applies the framework to recent experience of five countries: Ethiopia, Ghana, Mozambique, Tanzania, and Uganda.
- Highlights coordination difficulties between monetary and fiscal policy when objectives conflict (notably: spending aid on domestic goods vs. avoiding excessive exchange rate appreciation).
Empirical application and country experience
- Countries examined: Ethiopia, Ghana, Mozambique, Tanzania, Uganda.
- Common difficulties identified:
- Coordinating monetary and fiscal policy in the face of conflicting objectives.
- Managing pressures on the nominal exchange rate and real exchange rates.
- Dealing with inflationary pressures stemming from large aid inflows.
- Constraints from absorptive capacity limiting effective use of aid.
Key thematic findings
- Absorptive capacity:
- Large aid increases can be constrained by limited absorptive capacity, affecting the pace and effectiveness of public spending.
- Dutch disease and exchange rates:
- Aid inflows can lead to exchange rate appreciation pressures, with implications for tradable-sector competitiveness (real exchange rates).
- Inflation and monetary policy:
- Monetary policy plays a distinct role in containing inflationary pressures associated with scaling up aid.
- Fiscal policy:
- Fiscal policy is central to allocating aid toward domestic goods and public investment, but may conflict with exchange-rate and monetary objectives.
Policy implications and recommendations
- Emphasize clear roles for monetary and fiscal policy to manage conflicting objectives when aid rises sharply.
- Prioritize coordination mechanisms between fiscal authorities and monetary authorities to:
- Mitigate excessive exchange rate appreciation.
- Control inflationary pressures.
- Improve absorptive capacity and sequencing of spending.
- Use policy instruments mindful of their differential impact on the monetary base, nominal exchange rate, real exchange rates, and domestic prices.