Policy Responses to Aid Surges in Countries with Limited International Capital Mobility: The Role of the Exchange Rate Regime

Andrew Berg (), Rafael Portillo and Luis-Felipe Zanna

No 2014/018, IMF Working Papers from International Monetary Fund

Abstract: We study the role of the exchange rate regime, reserve accumulation, and sterilization policies in the macroeconomics of aid surges. Absent sterilization, a peg allows for almost full aid absorption — an increase in the current account deficit net of aid—delivering the same effects as those of a flexible regime but with a necessary increase in inflation. Regardless of the regime, policies that limit absorption—and result in large accumulation of reserves—are welfare reducing: they help reduce the real appreciation (and inflation under the peg), but at the expense of reducing private consumption and investment, and therefore medium-term growth.

Keywords: WP; exchange rate; central bank; managed float; Africa; Aid; Exchange Rate Regimes; Reserve Accumulation Policies; Sterilization Policies; Transfer Problem; appreciation pressure; nominal exchange rate; depreciation rate; managed float regime; nominal interest rate; open economy; inflation expectation; real gross domestic product; transmission mechanism; expenditure switching; flexible exchange rate regime; reserve holding; Exchange rate arrangements; Reserves accumulation; Sterilization; Conventional peg; Exchange rate flexibility; Sub-Saharan Africa (search for similar items in EconPapers)
Pages: 41
Date: 2014-01-30
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Journal Article: Policy Responses to Aid Surges in Countries with Limited International Capital Mobility: The Role of the Exchange Rate Regime (2015)
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