Short-period macroeconomic aspects of foreign aid

By concentrating on the supply side, the existing literature on foreign aid, e.g. the Two Gap or the Dutch Disease model, neglected the role that foreign aid might also play in influencing the level of domestic demand. This paper redresses the balance. It analyses the role of foreign aid in the short period by incorporating problems of both effective demand and supply side constraints. The analysis shows how and why aid can be useful or wasteful, especially in the context of economic liberalisation. This may, for example, imply that an increase in foreign aid has to be combined with an appropriate expansionary domestic demand policy in order to stimulate domestic employment and output.