The Macroeconomics of Managing Increased Aid: Country Experiences “Global Conference on Gearing...
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Transcript of The Macroeconomics of Managing Increased Aid: Country Experiences “Global Conference on Gearing...
The Macroeconomics of Managing
Increased Aid: Country Experiences
“Global Conference on Gearing Macroeconomic Policies to Reverse the HIV/AIDS Epidemic”
November 2006
Jan Kees MartijnInternational Monetary Fund
Outline
A framework for assessing macro implications of increasing aid: absorption and spending
Findings from case studies Prescription under IMF-supported
programs Related evidence on monetary
programs Concluding thoughts
Defining Spending and Absorption
Spending of aid: widening of the fiscal deficit, net of aid, as a result of new aid.– Spending = (Govt. expenditures-Domestic
revenues)/Aid
Absorption: widening of the current account deficit, net of aid, in response to an increase in aid.– Absorption = (non-aid current account
deficit)/Aid– Central bank’s willingness to sell foreign
exchange is crucial.
Policy Responses – Four Options
1. Absorbed and Spent Textbook case where central bank
sells aid foreign exchange and fiscal deficit rises as aid is spent.
No change in money supply. Risks Dutch disease.
2. Absorbed but not Spent – Central bank sells foreign exchange
but fiscal deficit remains unchanged.
– Helps achieve stabilization, lower debt, provides resources for private investment.
3. Not Absorbed but Spent – Central bank accumulates foreign
exchange as reserves; fiscal deficit rises as aid is spent. No real resource transfer.
– Unsterilized: Money supply rises. Risks inflation.
– Sterilized: Crowding out of private sector. Costly domestic debt.
4. Not Absorbed, not Spent
– Central bank accumulates foreign exchange as reserves; fiscal deficit net of aid unchanged. No real resource transfer.
– Equivalent to rejecting aid (in long run).
Main Findings (1)
No evidence of Dutch disease—real exchange rates did not appreciate.
Real Effective Exchange Rate
60
80
100
120
140
t=-1 t=0 t=1 t=2 t=3
Aid surge period Ethiopia
Ghana MozambiqueTanzania Uganda
reference line=100
Main Findings (2)
Aid was not fully used—in no case was it both spent and absorbed.
Was Aid Absorbed?
-12
-8
-4
0
4
8
12
Ghana
Ethiop
ia
Moz
ambiq
ue
Tanza
nia
Uganda
in p
erce
nt G
DP
Increase in Aid
Increase in Current Account Deficit Netof Aid
Was Aid Spent?
-2
0
2
4
6
8
in p
erce
nt G
DP
Increase in Budgetary Aid
Increase in Fiscal Deficit Net of Aid
Main Findings (3)
Some countries neither spent nor absorbed: aid went into reserves and spending did not increase.– Ghana, Ethiopia– Why? Desire to build up reserves or smooth
volatile aid flows
Some countries spent the aid but resisted absorption. This amounts to domestic financing of spending.– Most common, though unattractive, response:
Tanzania, Uganda, Mozambique.– Why this choice? One factor: fear of
appreciation.
What Did the IMF Program Prescribe?
PRGF programs generally encouraged an absorb-and-spend policy.– Fiscal deficit net of aid incorporated planned
increases; reserve targets were modest.– In a few cases, absorption without spending
was envisaged when macro stability not established or domestic debt too high initially (e.g. Ghana)
However, PRGF programs often dealt with aid surprises more cautiously. Asymmetric adjusters with respect to aid surprises common.
Lesson: the Need for Coordinated fiscal and Monetary Policies
Coordinated choice. Either #1 or #4, depending on benefits of higher govt. spending vs. adverse impact of appreciation.
Uncoordinated outcome. Suppose also that the Minister controls spending and the CB controls absorption. This could lead to suboptimal outcome (#3).
1. Spend and Absorb
2. Absorb but not Spend
3. Spend but not Absorb
4. Neither spend nor absorb
Competing objectives. Suppose the Minister of Finance (and donors) care mostly about increasing spending and the central bank mainly dislikes appreciation.
Performance under Monetary Programs
Corresponding performance under monetary programs: reserves higher and domestic credit lower than programmed under IMF programs.
(based on 1999-2004 performance of 15 Post-stabilization LICs)
Background: The Monetary Impact of Aid
When the government receives aid, it sells foreign exchange to the central bank and gets local currency deposits.
ΔNFA=-(ΔNDA), no effect on reserve money.
Aid spent → govt. draws down deposits, NDA and money increase.
Now CB faces a choice: sell foreign exchange, sterilize, or allow inflation.
NFA +100 RM 0NDA -100
NFA +100 RM +100NDA 0
Central Bank Balance Sheet
Central Bank Balance SheetAid inflows and money supply
Outcomet-2 t-1 t(1) t(2)
Projected
Inflation (end year CPI) 4.1 4.9 6.0 5.9 6.3 Inflation (GDP deflator) 4.3 5.2 6.3 6.1 6.8 Real GDP growth 6.0 5.9 4.9 4.9 5.1 Broad money growth 12.0 12.3 12.2 13.3 17.5 Reserve money growth 10.5 9.7 10.3 15.7 NDA contribution -0.6 -6.8 -7.8 -11.5 NFA contribution 10.3 16.4 18.2 27.1 Velocity (% change) -0.6 -0.4 -1.6 -4.3 Money multiplier (% change) 1.6 2.7 3.1 2.4
# observations 29 43 54 54 54
Deviations from projections 3/ 4/
Inflation (end year CPI) -0.7 -0.5 -0.3 -0.4 Inflation (GDP deflator) -1.0 -1.0 -0.5 -0.7 Real GDP growth 0.2 0.6 -0.2 -0.2 Broad money growth -4.5 ** -5.9 *** -5.4 *** -4.3 *** Reserve money growth -4.6 * -6.0 *** -5.4 *** NDA contributio 6.9 5.1 3.7 NFA contributio -13.1 -11.3 ** -8.9 * Velocity (% change) 4.5 *** 3.8 *** 2.7 *** Money multiplier (% change) -1.4 0.2 0.7
Projection as of 1/
Monetary Projections and Projection Deviations (averages, in percent)
Main Findings on Monetary Performance
While inflation objectives are generally met,
Money growth is higher than projected With significantly higher reserves – in
part due to the lack of absorption of aid inflows
Which is partly offset by lower domestic credit – in part due to sterilization using domestic instruments
The Post-Stabilization LICs
Country list: Albania, Azerbaijan, Bangladesh, Benin, Ethiopia, Guyana, Honduras, Kyrgyz Republic, Madagascar, Mongolia, Mozambique, Rwanda, Senegal, Tanzania, and Uganda.
Concluding Thoughts
“Spend and absorb” is the only sensible response to aid in the long run.– Some real appreciation may be necessary to
enable reallocation.– When maintaining a peg, some inflation may
be necessary as a relative price adjustment (and reallocation of resources).
– In the short run, other options may be considered (e.g., building reserves)—as in Ghana, Ethiopia
“Spend and not absorb” is problematic option because it leads to deficit financing. If aid is to increase reserves, it can’t also finance spending. Yet this is a common response.
Ensure coordination between fiscal and monetary policies.