Foreign Aid, Public Spending, Optimal Fiscal and Monetary Policies, and Long-Run Growth

Liutang Gong, Yuzhe Zhang () and Heng-Fu Zou ()

No 309, CEMA Working Papers from China Economics and Management Academy, Central University of Finance and Economics

Abstract: This paper presents a group of models showing the strikingly different implications of foreign aid to the private sector and public sector. In the first model, with decentralized decision-making and without optimal choices of fiscal policies on behalf of the government, foreign aid to the private sector has no effect on the long-run capital accumulation and it raises private consumption one to one; whereas foreign aid to the government leads to more public spending and higher private capital accumulation. In another model with optimal choices of both fiscal and monetary policies, foreign aid to the private sector gives rise to higher inflation and income taxation. Although aid to the private sector raises private money holdings and consumption, it reduces capital accumulation. However, when foreign aid is provided to the public sector, the government cuts both the inflation rate and the income tax rate, raises public spending, and provides more incentives for private capital accumulation and money holdings. In the long run, aid to the public sector leads to more private capital accumulation, consumption, money holdings, and welfare.

Keywords: Foreign aid; Capital accumulation; Income taxation; Inflation; Growth (search for similar items in EconPapers)
JEL-codes: E2 F34 F35 O1 O4 (search for similar items in EconPapers)
Pages: 28 pages
Date: 2008-03
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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