Fiscal Responses to Foreign Aid: Does the Permanence of Aid Matter?

Abstract

Abstract This paper shows that failing to distinguish between permanent (low frequency) and temporary (high frequency) aid results in misleading estimates of the fiscal responses to aid. I focus on foreign grants received by sub-Saharan Africa over the period 1990–2016, and I separately identify the fiscal responses to permanent and temporary foreign aid. Permanent and temporary aid generates fiscal responses that are meaningfully different on the components of expenditure and domestic borrowing. Temporary aid is associated with fiscal adjustments, such as lower domestic borrowing and increasing recurrent expenditure, while permanent aid is associated with higher public investments. Results provide important policy implications regarding the macroeconomic effects of foreign aid and the design of aid programs to developing countries.