Monetary Policy Rules For Manging Aid Surges In Africa

Abstract

We examine 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, we show 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.Basle Committee, capital adequacy, financial governance, financial architecture, financial reform, international standards, capital flows, poor countries, cost of capital, international development