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Monetary policies for an MDG-related scaling up of ODA to combat HIV/AIDS

Prepared for the Global Conference on Macroeconomic Policies to Reverse the HIV/AIDS Epidemic, Brasilia, 20-21 November 2006

Matías Vernengo
Assistant Professor, Department of Economics, University of Utah

International Poverty Centre (IPC)

March 2007

SARPN acknowledges the UNDP as a source of this document: www.undp-povertycentre.org
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Abstract

This Conference Paper discusses the best monetary policy to manage the macroeconomic effects of an MDG-related scaling up of aid inflows to address the HIV/AIDS pandemic. Many economists have expressed concern that a substantial scaling up of aid inflows would lead to greater inflation and real exchange rate overvaluation. Thus, in such a context, they often advocate that central banks adopt restrictive monetary policies. However, such policies often make overvaluation worse by driving up the interest rate and reducing domestic liquidity. This paper suggests that the evidence on the overvaluation effects of aid inflows is thin, at best. Instead of advocating restrictive policies, this paper maintains that monetary policies should maintain low rates of interest, increase overall liquidity in the economy and maintain a relatively depreciated currency. Such policies will help support the expansion of fiscal space that will be necessary for reaching the MDG target of halting and reversing the HIV/AIDS pandemic. A substantial increase in ODA directed towards combating HIV/AIDS will lead to an expansion of government spending on domestic goods and services. But the impact of such spending will not necessarily be inflationary in economies, such as those of many low-income countries, which have significant excess capacity, i.e., underemployed labour and other productive factors.



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