Welfare Gains of Aid Indexation in Small Open Economies

April 1, 2008

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Format: Chicago

Anubha Dhasmana. Welfare Gains of Aid Indexation in Small Open Economies, (USA: International Monetary Fund, 2008) accessed December 22, 2024

Disclaimer: This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate

Summary

Foreign aid flows to poor, aid-dependent economies are highly volatile and pro-cyclical. Shortfalls in aid coincide with shortfalls in GDP and government revenues. This increases the consumption volatility in aid dependent countries, thereby causing substantial welfare losses. This paper finds that indexing aid flows to exogenous shocks like a change in the terms of trade can significantly improve the welfare of aid-dependent country by lowering its output and consumption volatility. Compared to the benchmark specification with stochastic aid flows, indexation of aid flows to terms of trade shocks can reduce the cost of business cycle fluctuations in the recipient country by four percent of permanent consumption. Moreover, use of indexed aid can allow donors to reduce the aid flows by three percent without lowering the level of welfare in the recipient country.

Subject: Agricultural commodities, Aid flows, Consumption, Exports, Terms of trade

Keywords: Business cycle, Developing country, WP

Publication Details

Pages:

38
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 2008/101
Stock No:

WPIEA2008101
ISBN:

9781451869620
ISSN:

1018-5941

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