Gearing Macroeconomic Policies to Manage Large Inflows of ODA

Abstract

This paper examines how macroeconomic policies can be managed to accommodate a large inflow of foreign aid to combat the HIV/AIDS epidemic and still maintain macroeconomic stability. Because of the daunting scale of this epidemic, funds need to be disbursed urgently in order to contain its spread, yet some economists worry that rapidly scaling up foreign assistance for this purpose will cause inflation and appreciation of the real exchange rate. If such effects occur, they could impair a country’s international competitiveness and endanger its growth prospects. However, this paper maintains that such effects can be minimized if governments and central banks coordinate fiscal, monetary and exchange rate policies. If they do, they should be able to both ‘spend’ aid in order to finance larger government programmes and ‘absorb’ aid in order to import more real resources. Often, governments that receive foreign aid neither spend nor absorb it fully, defeating the basic purpose of development assistance. Because governments fear inflation, they are reluctant to finance a significant increase in spending on HIV/AIDS programmes even when the funding is available. Central banks are reluctant to sell the foreign currency they receive from HIV/AID related aid because they fear

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