This paper assesses the optimal setting of fiscal spending and foreign exchange rate intervention policies in response to volatile foreign aid, in a small open economy model that incorporates typical features of low-income countries. Within a class of policy rules, it jointly considers the...

A volatile pattern of government spending and its financing triggers uncertainty about the timing and the costs of assets sale in financial markets, thereby leading to higher interest rates. This, in turn, hampers the extension of credit to businesses and individuals. The empirical results...