Optimal Fiscal Spending and Reserve Accumulation Policies under Volatile Aid

Ioana Moldovan, Shu-Chun Yang and Luis-Felipe Zanna

No 2019/126, IMF Working Papers from International Monetary Fund

Abstract: This paper assesses the optimal setting of fiscal spending and foreign exchange rate intervention policies in response to volatile foreign aid, in a small open economy model that incorporates typical features of low-income countries. Within a class of policy rules, it jointly considers the optimal aid spending and international reserve accumulation policies. The results show that it is optimal to adjust government spending gradually in response to unpredictable fluctuations in aid, while partially accumulating foreign exchange reserves to offset Dutch disease effects. Also, allocating relatively more of the government spending to productive public investment, and less to government consumption, is welfare improving.

Keywords: WP; government spending; public goods; aid; fiscal policy; foreign exchange intervention; optimal policy; low-income countries; gradual spending; depreciation rate; spending policy; CES consumption basket; hand-to-mouth consumer; consumption decision; aid spending; spending of aid; spending process; goods sector; gradual aid spending; consumption level; Public investment spending; Consumption; Reserves accumulation; Private consumption; Sub-Saharan Africa; Africa; reserve accumulation policy; impulse response; welfare change (search for similar items in EconPapers)
Pages: 45
Date: 2019-06-11
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