Monetary Policy Frameworks for Emerging Markets

Monetary Policy Frameworks for Emerging Markets

Edited by Gill Hammond, Ravi Kanbur and Eswar Prasad

Financial globalization has made monetary policy formulation in emerging market economies increasingly complicated. This timely set of studies looks at the turmoil in global financial markets, which coupled with volatile inflation poses serious challenges for central banks in these countries. Featuring papers from the research frontier and front-line policymakers in developing and emerging market economies, the book addresses questions such as ‘What monetary policy framework is most suitable for these countries to confront the new challenges while they continue to open up to trade and financial flows?’, ‘What are the linkages between monetary stability and financial stability?’ and ‘Is inflation targeting or a fixed exchange rate regime preferable for developing and emerging markets?’

Chapter 6: Aid Reversals, Credibility and Macroeconomic Policy

Edward Buffie, Christopher Adam, Stephen O’Connell and Catherine Pattillo

Subjects: development studies, development economics, economics and finance, development economics, money and banking

Extract

Edward Buffie, Christopher Adam, Stephen O’Connell and Catherine Pattillo* 6.1 INTRODUCTION To absorb and spend the aid would appear to be the appropriate response under ‘normal’ circumstances. (Berg et al., 2007, p. 19) Surprisingly, a full absorb-and-spend response is not observed in any of the sample countries. (Berg et al., 2007, p. 36) In all countries, part of the aid increment was lost through reductions in the rate of capital inflow. In Ghana, the deterioration in the non-aid capital account exceeded the entire increment in the aid inflow. In Tanzania and Uganda, the reduction in the rate of non-aid capital inflows was comparable to the aid surge. (Berg et al., 2007, p. 28) The G8 countries have pledged to increase aid dramatically to sub-Saharan Africa (SSA) in an effort to meet the Millennium Development Goals. It is not clear, however, that a big aid push is realistic. Seven country studies recently completed at the International Monetary Fund (IMF) (Berg et al., 2007) and the Overseas Development Institute (ODI) (Foster and Killick, 2006) found that the current account deficit usually increases by less than half of the rise in aid flows and that aid surges often coincide with large capital outflows. These are disconcerting correlations. If the current account deficit does not increase by the same amount as aid, the transfer of real resources is incomplete. A substantial part of aid ends up financing capital flight or reserve accumulation instead of worthy projects. The IMF contends that these problems stem from...

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