Aid, Growth, and Real Exchange Rate Dynamics

Shantayanan Devarajan, Delfin Go, Sherman Robinson and Karen Thierfelder

No 332129, Conference papers from Purdue University, Center for Global Trade Analysis, Global Trade Analysis Project

Abstract: We argue that if aid is about the future and recipients are able to plan consumption and investment decisions optimally over time, then the potential problem of an aid-induced appreciation of the real exchange rate (Dutch disease) does not occur. Furthermore, greater economic flexibility and an increasing degree of integration to the global economy will intensify the changes in the real exchange rate as well as investment, consumption and exports. This key result is derived without requiring additional assumptions such as exogenous or endogenous productivity growth. The economic framework is a standard neoclassical growth model, based on the familiar Salter-Swan characterization of an open economy, with full dynamic savings and investment decisions. It does require that the model is fully dynamic in both savings and investment decisions. An important assumption is that aid should be predictable for intertemporal smoothing to take place. If aid volatility forces recipients to be constrained and myopic, Dutch disease problems become an issue. In short, any unfavorable macroeconomic dynamics of scaled-up aid are the result of donor behavior rather than the functioning of recipient economies.

Keywords: International Relations/Trade; International Development (search for similar items in EconPapers)
Pages: 38
Date: 2011
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Working Paper: Aid, growth, and real exchange rate dynamics (2008)
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Persistent link: https://EconPapers.repec.org/RePEc:ags:pugtwp:332129

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