The Macroeconomics of Managing Increased Aid Inflows:

Experiences of Low-Income Countries and Policy Implications

Prepared by the Policy Development and Review Department
(In consultation with the Area, Fiscal, Monetary and Financial Systems, and Research Departments)

August 8, 2005

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Contents

Executive Summary

1. Introduction
2. A Macroeconomic Framework for the Analysis of Increases in Aid Inflows
3. Findings from Country Cases
   1. The Pattern of Aid Inflows
   2. Macroeconomic Context
   3. Real Exchange Rate and Dutch Disease
   4. Was Incremental Aid Absorbed?
   5. Was Incremental Aid Spent?
   6. Monetary Impact of Aid and Policy Response
4. Conclusions and Policy Implications
   1. Summary of Findings
   2. PRGF Program Design Issues
5. Final Considerations

Text Boxes
1. Absorption, Spending, and Central Bank and Fiscal Accounting
2. Terms of Trade Shocks and Aid Inflows
3. Aid Volatility and the PRGF-Supported Programs

Figures
1. Total Net Budget Aid
2. Changes in Composition of Budgetary Aid
3. Exchange Rates and Aid Inflows
4a. Programmed vs. Actual Levels of Fiscal Deficit (Excluding Aid) and Net Budgetary Aid
4b. Programmed vs. Actual Levels of Fiscal Deficit (Excluding Aid) and Net Budgetary Aid
5. Ethiopia and Ghana: Monetary Indicators
6. Ethiopia and Ghana: Limited Aid Impact
7a. Tanzania and Uganda: Monetary Indicators
7b. Mozambique: Monetary Indicators
8. Mozambique, Tanzania and Uganda: Domestic Expenditure Exceeds Absorption

Tables
1. Patterns of Aid Inflows
2. GDP Growth, Inflation and Private Investment
3. The Real Effective Exchange Rate
4. Balance of Payments Identity
5. Allocation of Incremental Net Budgetary Aid: Spent or Saved
6. Domestic Debt and Debt Service Indicators
7. Classification by Aid Absorption and Expenditure

Appendices
I. Methodology for Sample Selection
II. Dutch Disease: Theory and Evidence

References