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The Macroeconomic Challenge of Aid Volatility

The Macroeconomic Challenge of Aid Volatility. African Department International Monetary Fund. Andrew Berg Calvin McDonald. Two dimensions. Horizon: short (intra-year), medium (1-3 years), and long Agent: donors and recipients. Short-run predictability: problems.

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The Macroeconomic Challenge of Aid Volatility

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  1. The Macroeconomic Challenge of Aid Volatility African Department International Monetary Fund Andrew Berg Calvin McDonald

  2. Two dimensions • Horizon: short (intra-year), medium (1-3 years), and long • Agent: donors and recipients.

  3. Short-run predictability: problems • Lots of volatility, even here. • Mix of reasons: sometimes country, sometimes “fickle donors”, usually in between • “innocent of what” • Program and project very different.

  4. Short-run predictability: solutions • Donors: can and are doing better • But move to budget support can make problem more acute. • Recipients should be able to smooth • IMF programs have come a ways on this • Even if IMF programs allow through adjusters, headline domestic borrowing and deficit targets can go awry.

  5. Medium-run predictability: problems • Again, lots of volatility • First principle component in a panel of aid flows explains 45 percent of the variation (Kang, et al. 2007) • Macro risks: can cause inflation, exchange rate and interest rate volatility. • Mainly because of problems of fiscal/monetary coordination. • May cause increase in size of domestically-financed public sector • Makes it hard to plan.

  6. Medium-run predictability: solutions • Donors • multi-year commitments etc. • Break link between donation and aid flow: global funds, Rethink budget support? • Recipients • Create good MTEFs, scaling up scenarios • Smooth aid • How many reserves do you need, and how costly? • Many countries have enough • Surprisingly hard to do. • Complications of exchange rate management • Separate central bank/fiscal decision making and even objectives

  7. Behavior of Aid Over Medium Term.

  8. Behavior of Aid Over Medium Term- Longer Series.

  9. How Many Reserves Do We Need To Smooth Aid Shocks?

  10. Country Specific Reserves.

  11. Long-run predictability • Irreducible and large uncertainty • Donors? • Recipient reactions • Smoothing infeasible and expensive • Aid-led strategy is fundamentally risky • Malawi fertilizer subsidy

  12. Final provocations/thoughts • Countries should figure out how to live with aid volatility • Vertical funds have merits • Notion of aid/policy interaction may be harmful as well as a bit flimsy • “We” should be prepared to support alternative/non-aid-led strategies too • We don’t pay enough attention to private capital flows: aid shocks seem to result in comparable private outflows on impact. • Donors? • Recipient reactions • Smoothing infeasible and expensive • Aid-led strategy is fundamentally risky • Malawi fertilizer subsidy

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