Working Papers - details - WEF0037
WEF0037
Aid volatility, monetary policy rules and the capital account in African economies
Christopher Adam, Stephen O’Connell, Edward Buffie
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Abstract
We examine the properties of simple quantity-based monetary policy rules of the kind widely used in
low-income African economies. Using a DSGE model and focusing our attention on responses to
positive aid shocks, we suggest that policy rules involving substantial reserve accumulation in the
face of aid surges serve to ease macroeconomic adjustment to shocks, particularly when a portion of
aid is used to support fiscal adjustment. These rules are robust to assumptions about the degree of
integration of the domestic public debt market with world capital markets. Although an open capital
account facilitates smoother adjustment to temporary aid surges when an aid inflow is fully spent, it
exacerbates the adjustment problem when aid is accompanied by fiscal adjustment and hence
reinforces the case for a managed float in such circumstances.