Aid and the Dutch disease: Macroeconomic management when everybody loves you

Countries that undertake serious and sustained programs of stabilization and structural adjustment should expect to attract significant new inflows of capital from donor countries and international institutions. While apparently beneficial, those flows can work at crosspurpose with other goals of the policy reforms. In particular, abundant foreign exchange loans can force an appreciation of the real exchange rate (often through domestic inflation rather than a nominal appreciation). In addition, since the government is almost always the recipient of these loans, it can crowd out the private sector if it increases its aggregate demand for domestic goods and services. If the crowding out is accomplished by tight monetary policy, it will fall primarily on private investment rather than consumption. This paper shows that both of these problems have surfaced in Ghana, a country that has become a favorite of donors after demonstrating a serious commitment to policies promoted by the World Bank and International Monetary Fund. The paper also suggests modifications in macroeconomic policy that would help lower inflation and boost private investment.