What is the Most Effective Monetary Policy for Aid-Receiving Countries?

This paper analyses how monetary policy can enhance the effectiveness of volatile aid flows. We find that monetary policy is effective in reducing trade balance volatility. We propose the following taxonomy, excluding the case of emergency assistance. Monetary policy should slow down consumption growth and build up international reserves when aid is abundant and deplete them to finance imports and support consumption when aid is scarce. If foreign aid also affects productivity growth, monetary policy should take this productivity effect into account in responding to aid flows.