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This research project was undertaken during Mr. Rayner’s internship at the IMF during the summer of 2008. The authors would like to thank Gian Maria Milesi-Ferretti for providing updated data on the net external position, Andy Berg, Peter Allum, and Martin Petri for useful discussions, and Francine Nyankiye for excellent research assistance. All remaining errors are, of course, ours.
For a complete list of the Millennium Development Goals, see the United Nations Millennium Development Goals website at http://www.un.org/millenniumgoals/.
In this study, we follow convention and define the real exchange rate as the relative price of non-tradables to tradables.
The Fully Modified OLS developed by Pedroni (2000) and the Panel Dynamic OLS estimator developed by Mark and Sul (2003) were also used as robustness checks. In most cases, the results were similar but less significant using these two techniques and will therefore not be reported.
A multiple equation estimation approach would certainly be preferred to this single equation approach. However, given data availability, it would not be feasible to accurately estimate a multiple equation system.
Only balanced panels were used for the PMG estimations.
See specifications V and VI in Table A3 of the appendix. Given the price of oil on the behavior of the real exchange rate in oil exporting countries, those countries were excluded from the sample in Table A3. A separate specification for oil-exporting countries can be seen in Table A4 of the appendix.
Due to data limitations, regressions that included both ODA and REM did not generally provide meaningful results.
We are indebted to Peter Allum for the insight into this measure of grant spending.
Grants that are spent by the government on tradables do not result in a sustained net foreign asset accumulation. This is less clear-cut when grants finance a tax reduction, and the private sector purchases tradables: the impact on net foreign assets will depend on the exchange rate policy, with possible NFA build-up under a float. However, grants-based tax reductions a relatively uncommon, and are not expected to undermine the general validity of the ODA2 measure developed below.
The monetary authorities can also use aid to supply foreign exchange liquidity, which could have an impact on the real exchange rate. This study is not concerned with this effect, although this is indirectly captured in the change in ΔNFA in equation (4). For a more detailed description of this channel, see Berg et al. (2007).
Because ODA1 and ODA2 can take a value of zero, their values are not expressed in logarithms (see Table A1). Their coefficients, therefore should be interpreted as semi-elasticities rather than elasticities as is the case for ODA.
Following the recommendations of Saadi-Sedik and Petri (2006) the fundamentals were not smoothed to avoid influencing the disequilibrium results in an arbitrary fashion.
Due to the important role of the price of oil in determining the ERER in oil exporting countries, Figures A3 and A4 were calculated on the basis of Table A4. Also, Chad and Sudan are included in the non-oil group as they have only recently begun to export oil. Cote d’Ivoire is included with the oil exporters to reflect its large oil refinery sector.