Publication Date: September, 2010
JEL Classification: C23, F31, F35
Key words: Foreign Aid; Real Exchange Rate; Pooled Mean Group
Document Size: 38 pages
The aim of this paper is to re-examine the relationship between foreign aid andthe real exchange rate, using the recent econometric methods developed for nonstationarydynamic panels and an estimator that imposes a weaker homogeneityassumption on the slope coefficients. The investigation shows that foreign aid ledto an appreciation of the real exchange over the period 1975-2005. In addition,the paper finds that other variables, such as labour productivity (a proxy forBalassa-Samuelson effect), terms of trade improvement, and governmentconsumption of non-tradable goods are also associated with an appreciation ofthe real exchange rate. To avoid an appreciation of the real exchange rate and adecline in competiveness, we recommend that WAEMU countries use foreignexchange from aid inflows to import capital goods, which will not only lead toexport expansion, but also to faster economic growth.