Managing Reductions in Aid Inflows : Assessing Policy Choices in Haiti

A low-income country such as Haiti that confronts an environment of diminishing aidinflows must assess tradeoffs among the available policy options: spending cuts,monetization, sales of debt, or use of foreign reserves. To provide the analytical tools forthis task, the paper draws from a set of DSGE models recently developed to evaluatepolicy choices in low-income countries for which external aid flows represent animportant revenue source. Two simplified stylized variations of the main model are usedto gain intuition and initially assess the trdeaoffs. Subsequenctly a full-scale small openeconomy DSGE model, calibrated to match conditions in Haiti and in similar low-incomecountries, is employed. Several key results are common to all model versions. While salesof foreign exchange reserves can compensate for the loss of aid inflows, this strategy isnot sustainable. The remaining policy choices entail larger welfare costs, involving lowerconsumption levels and real depreciation. The results suggest that a mixture of spendingcuts and depreciation is the best strategy, when use of foreign reserves is constrained