Monetary Policy Rules For Managing Aid Surges In Africa

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Review Of Development Economics


This paper examines the properties of alternative monetary policy rules in response to large aid surges in low‐income countries characterized by incomplete capital market integration and currency substitution. Using a dynamic stochastic general equilibrium model, it is shown that simple monetary rules that stabilize the path of expected future seigniorage for a given aid flow have attractive properties relative to a range of conventional alternatives, including those involving heavy reliance on bond sterilization or a commitment to a pure exchange rate float. These simple rules, which are shown to be robust across a range of fiscal responses to aid inflows, appear to be consistent with actual responses to recent aid surges in a range of post‐stabilization countries in Sub‐Saharan Africa.