Macroeconomic Effects of Foreign Aid in Ethiopia using Dynamic Computable General Equilibrium Model

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Addis Ababa University


Macroeconomic effects of foreign aid depend on how it affects savings, investment and government behaviour. The study used recursive dynamic general equilibrium (DCGE), auto regressive distributed lag model approach to cointegration (ARDL) and vivid three gap based descriptive reports aiming to find out the preponderant effect. The data used in descrptive analysis and ARDL were collected from World Bank, Organization for Economic Cooperation and Development, and International Monetary Fund data bases. DCGE requires social accounting matrix (SAM) and that was obtained from Ethiopian Development Research Institute (EDRI). The SAM was built in 2005 and updated its key accounts in 20091. Using recursive DCGE, the study shows that aid inflow can result in export reduction and exchange rate appreciation. But, it leads to higher gevernemt revenue, expenditure and savings. Aid‟s effect in total absorption and gross domestic product is not discernible. Thus, the study‟s results are ambiguous to generalize. The long run results of the ARDL model also show significant positive relationship between national income and domestic savings. However, the relationsip between Development Assistance Committee (DAC)-aid inflow and domestic savings is significantly inverse2.1 The recursive feature of the model ensures generation of SAM in years when SAM was not actually collected. 2 A 1 unit increment in DAC-aid inflow results in 0.5 unit reduction in domestic savings.



Macroeconomic Effects of Foreign